Be Mindful of Risks
by Mashum Mollah Management 24 January 2020
During times of uncertainty, investors can feel extremely averse to taking risks. While it is important to be aware and fully comprehend potential risks when it comes to investing, complete risk avoidance can limit investment growth. We should know how to be mindful of risks.
One of the significant risks investors face is permanently losing money, and this can often be a result of paying too much for an asset. Knowledgeable investment managers make their decisions based on valuation strategies, e.g. invest in stocks that are trading at a discounted value and sell once he/she feels the intrinsic value has been reached.
Steps How To Be Mindful of Risks:
Is it a risky business?
Does a riskier business make it a risky investment? Not necessarily. It’s possible that the company thought to have high-risk exposure may have a range of possible outcomes – positive and negative. In some instances, extreme negative outcomes could affect business sustainability, but the company could more likely be facing short-term challenges that could be overcome. So, it can be said that the presence of risk doesn’t inherently mean the business is unsuitable for investment.
It’s important to understand the impact that risk can have on sustainability and intrinsic value. Still, it should be noted that when the riskiness of a business is being evaluated for investment, the price you pay is vital.
One of the most powerful indicators of future returns and the risk you take on is the purchase price in relation to the asset’s intrinsic value.
The share price of a company is a reflection of the market’s expectation of its performance in the future. If the business has a low price relative to its fundamentals, it suggests that the market expects it to perform poorly. However, there’s a possibility that it could exceed expectations typically resulting in a price increase.
Sometimes, market participants may not focus on the fundamentals of business because they see the risks as overwhelming and so they become averse to the risk.
Sentiment towards a company can be influenced by obvious risks. This can cause overt pessimism by potential investors – even if the company has a proven track record of successfully overcoming challenges and generating good returns.
How to cut through all of the chatter
As an investor, it’s beneficial to cut through the noise, meaning you should look through the good and the bad news because it can help you when evaluating long-term reality. Where negative news is abundant, and the risks are apparent, there can be opportunities for a patient investor. If you’re willing to take on risk where it’s warranted, you can reap the rewards of a higher return.
Priced for perfection
Excellent investment opportunities don’t seem to be easy to find in areas of the market where there is optimism. Shares may look low risk; however, it’s possible that their fundamental values are often not as strong as the prices suggest and so portfolios should be built to manage the risk or be mindful of risks we take on to generate returns.
Based on this, potential investors should exercise caution when evaluating these companies. When shares are priced for perfection, their price trajectory can be fairly easily disrupted, e.g. through regulatory change.
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