Eat Well or Sleep Well……….or Both?
Posted June 6th, 2012
Eat well sleep well is a term used to describe risk and return with regards to investing. A consumer may wish to eat well by taking on more risk with their capital – which would hopefully yield greater returns. However, because of the risk the consumer may not sleep well. On the other hand a consumer may wish to sleep well without the nagging doubts the high risk investing incurs, but because of the lower return cannot afford to eat well.
It’s an interesting analogy but falls down upon any measure of closer scrutiny. One cannot spend their life eating or sleeping. Instead, we all aim to eat healthily and sleep well. In other words, we do both. Or we strive to. At this point I know I sound a little too literal and it is just an analogy after all. Is there any real reason though, since the analogy is out there, we can’t look to achieve a balance between both?
It all comes down to risk. What exactly is risk? Risk is the definition of loss weighed up against gain. I hesitate to say it is how much one is willing to lose. Is anybody really willing to lose anything? How much one is prepared to lose? Well again, if we are prepared for the loss can it be counted as a true loss?
If all I had was £100 with which to live would I be willing to lose it? Nope. Would I be prepared to throw it away? Well no. If it was all I had how can I have made provision for losing it? I decide to use it to place a bet on a horse which has odds of 4 to 1. A win would leave me with £500 in my pocket. Pretty nifty investing if it comes off. In monetary terms, they gain is much bigger than the loss. Obviously here there is a huge risk. What if I don’t win? The chances are I’m not going to. I would argue that a millionaire can take that bet, lose and it wouldn’t even register. However, to someone that has only £100 left, the loss of that initial £100 is greater than the (unlikely) gain of an extra £400.
And how will this make you feel. Will you ever recover…
Balancing risk is very important when it comes to long term investing. You should never risk more than you can afford to lose. A lesson that should be taught when we are very young.
If you are one that doesn’t like the roller coaster ride of fluctuations in investing, but you aren’t quite feeling the returns you would like, then perhaps a bit less sleep is the remedy. However, if the risk is getting a bit too much and you find you aren’t quite getting the “sleep” you need, perhaps cutting your risk a little may be the answer. It is a balancing act. How much of one you are willing to trade off against the other? Being completely honest with yourself about the returns you want to make is one of the first steps to investing. Then you must ask yourself if it is viable when married to how much of a risk you are willing to take.
Are you actually willing to take that risk? Astute financial planning can give you the framework to understand how much you can afford or better still need to take. Remember risk and reward are related. Better to know where this may lead you before investing than after.
By investing in a wide range of components (Asset Allocation) you can balance risk and return and then work to keep costs down. Capital Markets work and have a history of providing or rewarding the long-term investors for the capital they supply and investments they make. There is no need to play the lottery when it comes to investing. Speculation costs money. Active management attempts to accurately predict the weather, in one area. Passive management will tell you, there will be a lot of weather in a lot of places. So bring your sun lounger and your wellies.
That way, you’re taking less of a risk when asking yourself what the weather will be like.
And you won’t be kept awake wondering if it will rain.
Image credit – Flickr/jontintinjordan