Introduction
What are Investments?
- An investment can have a variety of meanings. It is commonly used in the fields of finance and economics.
- In the field of finance for example, an investment could refer to something that an individual—most likely an investor, would spend money for, expecting for a gain, yield, or simply, a return on his investment, either on a short or a long term basis .
- An investment may always carry a certain degree of risk
- Examples of investments
- Equities
- Bonds
- Stocks
- Securities
- Properties
- Anything that is subject to inflation
- Trading on the other hand is similar to making an investment only that it is done in a more active, frequent, and prolific manner.
- All traders are investors but not all investors are traders
- Investors usually rely on long term investments while the assets that traders usually buy may vary. The waiting time before a trader gets the full amount of his investment through gains may be as long as several years and can be as short as several seconds.
- This paper will revolve on the topic of mitigating disasters in trading and investments
Mitigating Disasters in Trading and Investments
- Disasters can happen everywhere, even in the assets of a man knowledgeable in the fields of finance and economics, specifically, trading and investments
- Disasters such as the bankruptcy of a financial firm that relies on the purchase and selling of stocks, equities, and other securities; the complete loss of an investor or trader’s capital, are some of the most common examples of disasters in engaging with trading and investments
- These disasters will always be a part of trading and investments. There is no single law or theory that can keep an investor away from such disasters
- The main culprit behind financial and economic disasters is risk
- Every investment carries a certain amount of risk; even a knowledgeable, experienced, and well-decorated investor or trader still makes mistakes every once in a while, some more frequent than others .
- The same is certainly true for beginners in the field of trading and investment. They will most likely make 10 times more mistake than an experienced and knowledgeable investor.
- The sad thing about making mistake or being a victim of a disaster in this field is that it always costs money, a lot of money.
- Experienced investors know that there is not a single way for them to completely eliminate the risks.
- Investors can only do so much; in fact, the only thing that they can do is to recognize the fact that there is a risk, assess it, and create a mitigation plan about it .
- Every investor knows this and so knowing how to react based on the level of risks involved in a certain financial decision, especially if such decision is deemed necessary, is of paramount importance.
- Not knowing how to mitigate, or manage these risks in general, would be like treading into an unknown path, which if continues, may certainly lead to a disaster.
Risk Management
- Because of the fact that every investment carries a certain amount of risk that if left unmitigated or ignored for too long, could lead to a financial catastrophe.
- Risk management is an important aspect of every business. The principles applied in this field may well be applied in other disciplines, as long as they involve a certain degree of risk too. That alone makes trading and investments viable candidates.
- “Risk management refers to the identification, assessment, and prioritization of risks (defined in ISO 31000 as the effect of uncertainty on objectives, whether positive or negative) followed by coordinated and economical application of resources to minimize, monitor, and control the probability and or impact of unfortunate events or to maximize the realization of opportunities” .
- There are of course various types of risks and in the field of trading and investments, there are three main types of risks that an investor may encounter.
- Risk management is generally viewed as a two-step process. The first step focuses on the determination, identification and assessment of the risk while the second one focuses on the formulation and execution of ways how the investor can handle the risks in such a way that makes them in line with his investment objectives.
- Risks are present everywhere in the financial world. It occurs when an investor prefers low-risk short term stocks over long term ones, when a financial institution conducts an investigation on a loan applicant’s credit history and rates him accordingly before issuing that person a line of credit, and basically everything that happens in the financial and economic world.
Types of Risks in Trading and Investments
- Business Risks
Bonds and stocks are some of the most common types of investments that an individual who wants to invest pursues. Bonds or stocks only become available when a company—a corporation, publicizes the ownership of the company and issues stocks which anyone who can afford may acquire. Purchasing stocks as a form of investment benefits the business by increasing the pool or the amount of their capital, and the investors by receiving profit dividend yields, interests, and the authority to sell their ownership after the stock prices go up significantly. However, every business carries a certain amount of risk as well. And so if a business goes bankrupt, that goes to say that the investments of the investors on that company go bankrupt too. One effective way to mitigate this risk is through the process of diversification—that is, dividing the investment fund and investing it on the purchase of stocks or bonds from different companies .
- Interest Rate and Inflationary Risk
This risk is applicable only when an investor invests his money on securities and other assets that offer a fixed amount of investment returns. So for every time an investor purchases securities that offer a million dollar in return over the course of 5 years for example, he exposes himself to this kind of risk. Over the course of five years, no one can really exactly predict whether the interest rates would go up or down. The only way to counteract the possible consequences of this risk is to decrease reliance on investments that offer a fixed amount of returns, especially, if the offered returns are not that particularly higher than the value of the investment required .
Inflationary risk is basically similar to interest rate risks only that the independent factor is not the interest rate but the inflation of prices which lead to the depreciation of value of a country’s currency. Inflationary risk may also be well applicable to investments that offer a fixed amount of returns. An investment return worth 1 million USD that will be made available after five years may not be equivalent to 1 million USD over the course of five years anymore due to inflation. Again, the key here is to select investments that offer investment returns that are significantly higher than the investment fund requirements. If possible, an investor may also project the possible inflationary rate in a particular country and calculate if it is still worth placing an investment despite the fixed returns. But then again, the best way to mitigate a financial disaster caused by this risk is to stay away from securities that offer a fixed amount of returns and go for the ones that offer returns based on varying factors such as a company’s profit as in the case of stocks and bonds.
- Market risk
This is by far the most complicated type of risk there is. This risk is also often called systematic risk because it affects all types of investments and securities the same way. This risk refers to an entire market that can be affected by literally a lot of factors which, unfortunately, cannot be addressed even through diversification of investments. This is the type of risk that an investor, no matter how experienced, could do nothing about but to recognize the fact that a particular market carries a certain level of risk. Investors who invest in mutual funds, which are mostly characterized by a high level of investment diversity, are not exempted to market risks .
Conclusion
Risks are non-removable variables in the field of trading and investment. And because of that, there will always be a likelihood that an economic or financial disaster would occur. There are cases wherein an investor may be able to distance himself from the effects of a certain risk, and possible prevent or if not, mitigate an upcoming financial disaster; but there may also be cases wherein all that he would be able to do is to recognize the risks and practically make a gamble , as in the case of market risks.
References
Borodzicz, E. (2005). Risk, Crisis, and Security Management. New York: Wiley.
Hopkin, P. (2012). Fundamentals of Risk Management 2nd Edition. Kogan Page.
Hubbard, D. (2009). The Failure of Risk Management: Why it's broken and how to fix it. John Wiley and Sons, 46.
Roehrig, P. (2006). Bet on Governance to Manage Outsourcing Risks. Business Trends Quarterly.
Trickey, G. (2012). Risk Types OP Matters No 14. The British Psychological Society.
