Warren Buffett, widely regarded as one of the world’s greatest investors, has famously asserted, “Risk comes from not knowing what you’re doing”. He’s correct, of course, but who admits that? “Risk management” in this context refers to the process of identifying, evaluating, and addressing the potential dangers posed by stock market investments. Due to inherent uncertainty and volatility, investing in stocks necessitates vigilant risk management. As a result of the unpredictability of stock prices, all investments carry the risk of loss.
The trouble with a lot of investors is that that are lured to an investment overwhelmingly by the potential gain. Of course, this is a natural reaction and on the face of it just fine. Who doesn’t want to make a quick buck? The challenge arises from the conflicting priorities of pursuing profit and the necessity to assess risk beforehand. Investors essentially are blinded by the potential riches and forget that starting with the risk in the investment is paramount to the potential return. As an investor, it’s always prudent to start with risk. Establish what you can lose and measure the return secondary. It’s important to recognize why this is usually not the case for most people.
The Potential For Higher Returns: Frequently, investors are prepared to accept greater risk in pursuit of higher returns. The stock market has historically outperformed other asset classes over the long term, but it is also more volatile. Long-term returns may be higher for investors willing to assume increased risk.
Behavioral Biases: We discuss this elsewhere, but it could be one of the strongest reasons for forgetting to evaluate the risk. Investors often overestimate their predictive abilities, leading them to make risky investments without a full understanding of the associated risks. Confirmation bias (selectively interpreting information that aligns with their existing beliefs,) social influence and fear of missing out (FOMO) are some of the more common ones that place highly in the brain.
Lack of Knowledge And Experience: Some investors may lack the knowledge and experience necessary to comprehend the risks associated with investments. This may cause them to make risky investments without a complete understanding of the hazards involved.
Focus On The Short Term: Certain investors may prioritize short-term gains over long-term objectives, compelling them to engage in riskier investment decisions in pursuit of immediate profits.
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