“Shameless” is a TV Series starring Emmy Rossum as Fiona Gallagher, the eldest of 6 siblings who had to look after everyone in the house because of their drunkard father and an absent mother, is a true reflection of an American working class whose struggles daily.
Fiona Gallagher in one of the episodes saw an opportunity to invest in a nursing home project in the South Side of Chicago so she took two loans against her apartment building for USD100k. There was an unexpected zoning delay and each investor had to fork out an additional USD25k which she didn’t have. In the end, she had to sell her apartment building at a huge discount to the market price to pay off her bank loan and the additional USD25k. She ended up broke again and on the streets after taking more risk than she could afford.
Closer to home, forex trading is considered a high-risk investment because it involves leverage, volatility, and speculation. Here are some case studies of forex trading disasters in Malaysia:
- In 2017, a group of forex traders in Penang lost over RM100 million to a forex scam syndicate that promised high returns of up to 18% per month. The syndicate lured the victims with attractive incentives, such as luxury cars and overseas trips, and used fake testimonials and endorsements from celebrities and politicians. The syndicate also claimed to have a license from Bank Negara Malaysia, the central bank of Malaysia. However, the syndicate was exposed when the victims did not receive their promised returns and the syndicate members went missing1.
- In 2018, a forex trader in Kuala Lumpur lost RM1.5 million in a single day after he made a wrong bet on the British pound. The trader, who had been trading forex for 10 years, was confident that the pound would rise after the Brexit referendum in 2016. However, the pound plunged to a 31-year low against the US dollar after the referendum, resulting in a huge loss for the trader. The trader said he was too greedy and did not set a stop-loss limit, which is a tool that automatically closes a position when the price reaches a certain level2.
- In 2019, a forex trader in Johor Bahru lost RM300,000 to a forex broker that turned out to be a fraud. The trader, who had been trading forex for 3 years, was introduced to the broker by a friend. The broker claimed to have a team of experts who could provide trading signals and advice. The trader deposited RM300,000 into the broker’s account and followed the broker’s recommendations. However, the trader soon realized that the broker was manipulating the prices and executing fake trades. The trader tried to withdraw his money, but the broker refused and blocked his contact3.
Determining the appropriate level of risk in an investment is a crucial aspect of financial management. While the potential for higher returns often accompanies higher risk, it’s essential to strike a balance that aligns with your financial goals, risk tolerance, and investment horizon. Here’s a comprehensive guide on how to assess and manage risk in your investments without jeopardizing your entire portfolio.
Understanding Risk
Risk in investment refers to the probability of losing money or not achieving the expected returns. Different investments carry varying degrees of risk, and understanding these risks is the first step in making informed decisions.
Define Your Financial Goals:
- Clearly articulate your financial goals, both short-term and long-term. Whether it’s saving for retirement, purchasing a home, or funding education, knowing your objectives will guide your risk tolerance.
Assess Your Risk Tolerance:
- Your risk tolerance is influenced by factors such as age, financial situation, and psychological disposition. Younger investors with more time until retirement may tolerate higher risk, while those nearing retirement may prefer a more conservative approach.
Diversification:
- Diversifying your investment portfolio across different asset classes, industries, and geographic regions helps spread risk. If one investment performs poorly, others may offset the losses. Diversification is a key strategy to manage risk without avoiding it altogether.
Risk Management Strategies
Asset Allocation:
- Determine the mix of assets in your portfolio based on your risk tolerance and investment goals. Asset allocation involves dividing your investments among different categories, such as stocks, bonds, and cash equivalents. Adjust the allocation as your goals and risk tolerance evolve.
Risk-Return Relationship:
- Understand the relationship between risk and return. Higher potential returns often come with higher risk. Balancing your desire for returns with your tolerance for risk is crucial. Be wary of investments promising high returns without commensurate risk.
Research and Due Diligence:
- Thoroughly research potential investments. Understand the market conditions, historical performance, and the company or asset’s fundamentals. Informed decisions based on comprehensive research can mitigate unforeseen risks.
Setting Limits
Stop-Loss Orders:
- Implementing stop-loss orders can limit potential losses. These orders automatically sell a security when it reaches a predetermined price, preventing further declines. While this strategy does not eliminate risk, it can protect against substantial losses.
Position Sizing:
- Determine the amount of capital to allocate to a specific investment. By limiting the size of each position, you spread risk across multiple investments, reducing the impact of a poor-performing asset on your overall portfolio.
Continuous Monitoring and Adaptation
Regular Portfolio Reassessment:
- Markets and economic conditions change over time. Regularly reassess your portfolio to ensure it aligns with your goals and risk tolerance. Adjust your asset allocation and investments accordingly.
Stay Informed:
- Keep abreast of market trends, economic indicators, and geopolitical events. Staying informed allows you to anticipate and respond to potential risks, making more informed decisions.
Seek Professional Advice
Consult a Financial Advisor:
- Seeking advice from a qualified financial advisor can provide personalized insights into your specific situation. A professional can help assess your risk tolerance, recommend suitable investment options, and offer guidance on adjusting your portfolio.
Education and Training:
- Invest time in educating yourself about different investment instruments and strategies. A well-informed investor is better equipped to navigate the complexities of the financial markets and make prudent decisions.
Psychological Preparedness
Emotional Discipline:
- Emotions can influence investment decisions, leading to impulsive actions. Develop emotional discipline and stick to your predetermined investment strategy, even during periods of market volatility.
Long-Term Perspective:
- Keep a long-term perspective. Short-term market fluctuations are inevitable, but a well-thought-out investment plan considers long-term trends and objectives. Avoid making decisions solely based on short-term market movements.
Balancing risk and return is an ongoing process that requires careful consideration, continuous monitoring, and adaptability. By defining your financial goals, assessing your risk tolerance, and implementing prudent risk management strategies, you can navigate the complex world of investments without jeopardizing your entire portfolio. Remember that there is no one-size-fits-all approach, and what works for one investor may not be suitable for another. Regularly reassess your financial situation, stay informed, and be prepared to adjust your investment strategy as needed. Ultimately, a well-informed and disciplined approach will help you achieve your financial objectives while minimizing unnecessary risk.
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