Compulsory risk investment

When we invest our money in the stock market, we’d like to earn a lot and risk very little. Surely it would be nice, and in fact theoretically you could build an investment portfolio that could allow you to cut down overall risk to near zero. But does something like that make sense? In my opinion, frankly, it does not. Let’s be clear, I’m not saying that you should not diversify your investments (all the contrary), but that you should accept a reasonable risk on your investment. If you don’t, then you should stay away from stock market and keep your money in a saving account or at most buy government bond.

I’m saying this because of how a portfolio works: risk is reduced because when one asset goes down, another goes up, compensating for the loss. But this way also profit is compensated, and therefore reduced. If you allow me an exaggerated example, it may be as gambling on both red and black in a roulette game: you win nearly every turn, but you win nothing.

When you invest in the stock market, you maybe should use a strategy slightly different from “minimize the risk”. In my opinion, you should start from imagining a scenario that you are convinced will come true, and invest accordingly. Surely, it’s right to prepare a “safety belt” in case things do not go as you planned, but you have to be aware that they’ll brake you also in profits. Risk is inborn in stock market investment, it’s sort of a law of nature (thus the “compulsory” we used in the title of this post).

For example, in my opinion if you’re convinced that “clean energy” will have a major role in the future, and it will increase in size and profit, you should invest in that sector, but you should not put your money also in the “polluting” energy sector, because it does not fit in the scenario you’ve chosen.

Clearly you can be wrong in choosing the scenario, but a relevant part in imagining scenarios is also give a probability they will happen. That probability is a first measure of the risk of your investment, and you should carefully think if it’s acceptable for you. Being careful that, if you’re not satisfied with risk, you should not invest, not simply trying changing the scenario that you believe will become true.

Italian translation of this post: Investimenti a rischio obbligato

Banche e Risparmio []


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