Friday, August 12, 2011

taking risk, when?

It has always been said that in order to achieve higher returns on your investments, you need to take bigger risks. But a better question would be, when should I take risks? and the answer is: when you can afford to. Its ironic how poor people spend a significant part of their income on buying lottery tickets or gambling when they have so much to lose. If someone steals 500 pesos from your wallet and you can't sleep at night because of it, then you are in a financial position where you cannot afford to lose such an amount. So why would you spend 500 on lotto or gambling or on a risky business. On the other hand, if someone runs away with 100,000 of your money and it doesn't affect you emotionally, then you are in a financial position to spend 100,000 on risky investment because you can afford to lose the money. If you start from zero, then have an emergency fund first, about 6 months worth of income stashed safely in a savings account. This money is relatively safe since thieves can't steal it and it is insured anyway. Then you start accumulating investments, starting from the least risky to the most risky. Maybe you begin with cash investments, then to bonds, then to real estate, then to mutual funds, then to the stock market, then to a small business, then to forex, then to hedge funds and so on. You can afford to take more risks as your net worth increases simply because you can now afford to lose money in case an investment fails. But if it performs well and gives you very high returns, then you become even richer. Such is the cycle of wealth and the prime reason why the rich get richer. On the other hand, most of the poor get poorer because they invest what little they have on risky investments, the worst of which is gambling it away, so they never even start to accumulate wealth.

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