Most, if not all, individual investors don’t understand the concept of risk. No one is interested in the efficient frontier. Risk is often only contemplated in hindsight: after the damage is done and they’ve taken a loss.
A view risk as falling into two categories:
1.) The risk of losing money
2) The risk of losing ALL of your money
It’s common knowledge that all investments involve risk. If you’re willing and able to stomach the ups and downs of the markets, the volatility, then you are willing to risk losing some of your money. Losses in this category can often be temporary, reversing if you are willing to hold on long enough. If you invest at all, you are willing to lose some, but not all, of your money. This would seem to be the prudent way handling investments over time.
Then there are endeavors and investments that afford you the potential of losing ALL your money. Small companies with the next great cure for disease, technology companies that your electrician told you are going to skyrocket, and plain old junk are the types of companies that can empty your accounts quicker than Charles Ponzi.
Why do some people invest in things where they can lose all of their money? You know the answer, ay? Come on! It’s greed right? Well, sort of. It’s greed combined with that old familiar scent: stupidity. Do you really think that your electrician has an edge? Do you really think you can determine which biotechnology company is going to produce the next big breakthrough?
I don’t understand what biotechnology companies do, so I don’t invest in them. There is a small micro cap biotech company out there that will fail and investors will lose ALL of their money that they have in it. It may take a month or it may take a year, but it will go to zero. I don’t care which one it is or when, because I won’t be there.
How do you avoid losing all of your money?
- Invest in things you understand
- Let the electrician fix the circuits
- Have realistic expectations of your investments and of yourself
- Work with a qualified advisor if you don’t have the time, interest or experience