A few years ago, I learned a course at a local college and a student who knew I was in the investment management profession stated that she thought investing in shares was related to gaming.
Was she right?
According to my American Heritage Dictionary, bets are investing in an uncertain result. Taking a risk hopes to get an advantage; or engage in ruthless or dangerous behavior. In view of the definitions, investments in shares, bonds or other securities may be considered as games. After all, you never know when you buy a band if the company will be on business when it is time to collect and pretty much everyone has figured out the stocks can go down as well as upwards.
Nevertheless, I think my student did not think of the word definition of games, but instead compared to investing in shares so that they were like pulling the lever on a slot machine, throwing death in a game of craps or playing black jack. Is it the same as these activities invest? It does not have to be.
Statistics show that Vegas games in the long run will lose money. That is how casinos can afford to build pyramids, castles and pirate ships. Investments, on the other hand, provide long-term gains. Certainly, all investments have any kind of risk associated with them. Risks accepted in the hope of profit. This is where we can take a lesson from Vegas.
What must Vegas learn? You can add a quarter to a slot machine and win $ 100, $ 10,000, or even $ 1 million. How can the casino survive giving away money in this way? You know the answer: Most of the time you enter your neighborhood and go away with nothing. Sure, someone sometimes goes away a winner but most people usually lose money. The casino can survive because they are prepared for temporary winners and can be quite patient while the rest of us transfer the money. They do not shut down the first time someone wins, disturbed over the accident. They continue to know that they will get the money back and then some.
Many people do not have that kind of patience. All they see are the risks in abundance.
In order to understand the investment risk, investors must accept some basic truths. Firstly, there is no such thing as a risk-free investment. Secondly, investors seeking greater investment gains must be willing to accept greater risk. Conversely, if an investor does not want to accept a certain level of risk, they must lower their expectations. Thirdly, the risks that an investor faces may vary depending on how long an investor has to achieve his investment goals. Finally, even if the risk can not be eliminated, it can be managed by careful planning and after a disciplined investment process.
One form of risk that everyone understands is the main risk. There is a risk that you will buy an investment that has a permanent depreciation. Exxon Bankruptcy is a perfect example, its bondholders receive only a few pennies on the dollar for their interest-bearing bonds and shareholders have seen their ranking go down to zero.
Another risk investor is volatility. There is a chance that on a particular day, financial markets can value your investment at a price greater or less than yesterday. Almost all investments are subject to the risk of volatility. Even rock-solid US government bonds fluctuate in value when interest rates move.
With volatility, you will not get yourself out of that risk by having a lot of shares, bonds or a fund. Instead, it takes time for the downturns on the market to be overcome by the upswing. Each type of investment has its own characteristics. Some only require a few months for ups and downs to cancel, some take decades. You must match your investment with the time you have for them to grow. The more time you have the better growth you can shoot for.
However, the risk that most investors ignore is inflation. This is the risk that a purchasing power dollar will fall. For example, over 25 years, 3% inflation will move over half of the purchasing power for every dollar you have. Attempting to avoid risk of capital and volatility by sticking to CDs or other guaranteed income accounts makes it difficult, if not impossible, for your investments to grow faster than inflation.
So does it invest like playing? It could be. But if you diversify your investments, be patient in the bad years and match your portfolio to the amount of time you have until you need the money, you will not eliminate risks, but you can eliminate the effects of these risks. That is what the casino owner can still smile when he writes a $ 1 million check to a super-grand-mega winner in slot machines. This is because he looks at all other machines that melt up a lot of quarters.