BOS up 580%, but how do we manage risk?
Bostoncoin update Sept-Oct 2021
What is risk and how do we manage it?
The fine-print on financial documents says “all investment involves risk”, but what exactly does that mean? Is it just the risk that your investment may go down? Are there different types of risk, and which ones do I need to know?
One of my favourite analogies for risk is a question, posed by a fund manager at a financial planning conference. He asked, “Two skydivers jump out of a plane. Person A is wearing a parachute; person B is not. Which person has the most risk?”
Please pause for a moment to answer the question in your own head before reading on for the answer.
What is risk?
Simply put, “risk” is the chance of something happening which you did not expect. In the above example, person B (wearing no parachute) could fully expect that they would descend quite rapidly and make a very sudden stop. There is no risk of any other outcome. The moment person B stepped out of the plane, their end result was a foregone conclusion.
Person A is actually the one who encounters risk. They have a parachute, and they expect to float gently down to earth. However, there is a tiny percentage risk that their parachute may malfunction, which could result in death.
It seems counterintuitive, as both skydivers were risking their lives; however one outcome was 100% certain, whilst one may have only been 99.99% certain. The remaining 0.01% was risk.
Types of risk
There are many types of risk (variations from an assumed outcome) in life. There are risks in driving a car, crossing the road, undergoing surgery, or even asking someone out on a date. Note well: The quality of your experience in life will be in direct proportion to your ability to understand and manage your risk.
Most people will look left and right (maybe twice) and then cross the road. Someone who is suffering from phobias or paranoia may become so terrified of crossing the road as to become housebound. Someone with no rationale may boldly walk across the road without looking, and will often become a statistic. Obviously, we wish to avoid the extremes of being too bold or too cautious, and live life happily with a modicum of risk and the appropriate reward.
Many of us have internal stories of times when we did not take a risk, and later regretted it. Most people have the “sliding doors” moment when they wonder, “What would have happened if I had told my high-school crush that I liked them? Would life have been better if I had taken that job? Where would I be now if I had bought that stock/land/crypto when I first heard of it, rather than a few years later?”
If you can understand that risk is not always sky-diving or life-threatening, then you can weigh up the pros and cons, and manage your risk appropriately.
If you confess your feelings to your crush and it is not reciprocated, it will not necessarily ruin your life, and there are plenty more fish in the sea. That dream job may or may not have worked out, but life goes on, and you will bounce back. Yes, we all wish that we had bought Bitcoin when it was under $3, but we cannot travel back in time, and in the next 10-15 years, you will probably be very happy that you got into the market when you did.
Most people think that investment risk is the risk that your investment will go down in value. This is true to a degree, however, there are other types of investment risk.
Market risk is the risk that your investment may not perform as well as the rest of the market. It is entirely possible that your investment goes down, sure, that is mostly covered under investment risk. If instead, your investment goes up by 10%, and the rest of the market goes up by 40%, you have just encountered market risk.
The best way to manage this type of risk is to diversify into different types of investment. Every few years there will be a crash in stocks, crypto, bonds or property. The idea is that if your investments are in different areas, a big crash in one area wil be balanced out by good performances in other areas.