At the heart of investing is risk taking. The very nature of investing money is that there is always a certain amount of risk involved. Is being a risk-taker the right choice when it comes to investing though?
On one hand, taking bigger risks often means bigger payoffs. For instance, when Justin Timberlake and his investing partners decided to invest in the social network site Myspace, the site was on a downward spiral. Since then, they’ve breathed new life into it, and it’s now showing clear signs of improvement.
However, there are downsides to taking a huge risk in the stock market, like losing your hard-earned money. Not everyone can take risks as large and high-profile as Justin Timberlake can. Considering these things before you decide to dive into the deep end on Wall Street will help you decide.
1. Plot Your Path
Before you choose to become a real risk-taker, create a realistic path to financial security and retirement. Figure out how much money you’ll need in retirement, and how you’ll get there. Do you currently have a 401(k) plan set up? Do you carry life insurance? With the current projection of your income, can you bounce back if you take a big hit on a risky investment?
If the answer to the last question is no, do not take risks. Only risk money you can afford to lose.
2. Assess Your Current Financial Position
Timberlake and his business partners were in a position to take a major hit if their MySpace venture failed. If you struggle to make your present financial commitments like a mortgage, car payment and other everyday expenses, don't take huge risks in the market. Though a big stock market win will erase your debts, losing all your money will cause greater hardships. Check out these articles on The Street for guidance on finding your way through the confusion of the market.
For those who can meet their financial obligations, and have money remaining, risk-taking can be a viable option. However, consider more intangibles to see if risk-taking is truly for you.
3. Take Risks for Larger Gains
Many times, big risks do offer bigger gains. They say “If you can’t beat them, join them.” That’s the mentality Facebook had when the company purchased Instagram last year for an astronomical reported $1 billion. Rather, it wanted to keep other companies from doing the same.
In reality, big risks pay off less often. If you don’t like the idea of suffering through several big losses, to make one or two big gains, becoming a risky investor is not for you. Sometimes big losses will scare investors away from the market.
Keep in mind, losing half of your investment account on one trade (a 50% loss) means you must earn 100% on your next trade just to break even. If you can't stand to lose half or more of your trading account, stay away from riskier investments.
If you can earn large gains on stocks regularly, or can replace your losses, you may want to consider taking a risk to land a big gain.
4. Consider Your Own Temperament
People have different investing personalities. Some investors like the idea of a secure, steady, return on their money, and abhor the idea of risking it on speculative picks. Still, other investors want to leverage their assets right away, and are comfortable taking large losses because they know bigger gains are just around the corner. These investors typically have complete faith in the market, and their investing skill.
If you’re unsure of your ability to recoup losses from a risky investment, it’s wise to choose steadier, more stable investments like bonds, mutual funds, or an ETF. These investments offer steady gains that beat inflation and lower risk. For most investors, this method is the safest, surest way to realize gains in the market.
There are many reasons to start taking more risks, and reasons to avoid them. Weigh the rewards against the downsides before you make a risky investment, and you'll be comfortable in your decision no matter what happens.