How To Use Risk Analysis To Make You A Better InvestorWhat is risk analysis? Shares - and for that matter any type of investment or speculation - carry an inherent risk. Mainly, the is the risk to capital - will you get your money back? To quote an old saying in finance, the return of your money is more important than the return on your money. There is no guarantee of any profits, dividend or interest payments, rates of return or any return at all. There are however, degrees of risk. By using risk analysis techniques it is possible to define types of risks and the level being taken and then to compare them with potential returns. This is known as the risk / reward ratio. It is by having a deep understanding and amazing ability to forecast returns and compare against other types of investment returns that Warren Buffett has been able to amass such a fortune. He is able to project rates of return into the future with reasonable accuracy and then compare that with other potential returns. He famously judges potential investments against 'risk free' T-Bills (United States government debt). If any of us had just half his understanding of risk analysis and comparison skills, we would be exceedingly wealthy! So, to help you in your quest for investment profits, the pages listed below in this section will offer some definitions of useful terms in understanding risk levels. There will also be space offered to the formulas required to calculate important ratios for yourself.
It is very powerful stuff and well worth studying for every investor. It is worth noting that some of these calculations are used less for risk assessment and more for company assessment. However, by definition, understanding and valuing a company is an integral part of understanding the risk of investing in it. As is mentioned on other parts of this website, a keen understanding of the risks being taken in a potential investment and in the holdings in a given portfolio is one of the key factors that separates amateur from professional money managers. Understanding the risk levels being taken in a portfolio is a vital skill and one that asset allocators spend a great deal of time learning and lots of computer processor time monitoring. We private investors should learn to follow the professionals! Of course, for the small amounts that most private investors manage, there are limits to just how useful assessing portfolio risk can really be. There have been, for example, several Nobel Prizes for Economics awarded to individuals that have studied portfolio risk management. While it can be interesting and instructive, it is a very complicated subject for most mere mortals (such as your author) to truly understand. Thus, the subjects discussed in the pages listed below offer descriptions of the most important risk analysis concepts and ratios that a private investor ought to face and really must understand. Click here to learn about:
|