The Fear Of Market Risks And How To Deal With It
Remember that feeling of discomfort running through you when you considered
putting your hard earned money into something that didn't guarantee fixed returns?
That feeling comes when there is a possibility of losing. And that same feeling
might have stopped you from buying something several years ago, whose price
today is many times more!
Most of us, let us accept, are not comfortable with the idea of calculated
risks and the only type of investment we consider are the very safe bank
deposits. We may be fascinated by the return the stock markets and real estate
have offered in the past few decades, yet the fear of market risks holds us
back. Our mind seems to be controlled by fear, and it strongly resists anything
that doesn't give a guarantee. This resistance often shows up in the form of
excuses. As a consequence, we miss out on many wealth-creating opportunities.
We tend to remain satisfied with whatever we have.
The same fear kills many brilliant business ideas and entrepreneurial
ambitions. Every time we hear of an investment or business success story, we
feel motivated. But when it comes to acting on it, the fear grips again, and we
are back to our seat.
Those who were successful with their investments in the past weren't fully
sure of the result at the time of investing. They knew they were taking a risk.
But they were not gambling either. They probably took a calculated risk and
didn't let the fear stop them.
But why is it that many of us are not able to think like that?
Why are we so risk-averse?
I believe the problem is with the way we are taught to think, right from
our childhood. We are programmed to aim for 100% perfection in everything we
do. There is a 'right way' to eat, walk and talk. Any deviation is unacceptable
and you just cannot afford to go wrong. The school toppers are applauded, and
failures looked down upon. Do the right thing in the right way, and ensure that
positive results are guaranteed. We grew up with this mindset and therefore,
even as adults, we tend to seek perfection and guarantee in everything we do.
Because of such a perfectionist mindset, we find it difficult to accept the
possibility of a negative outcome. Even when we know the risk is only 10%, we
resist it because success has to be 100% sure, not 90%.
It is quite clear that the culprit is not lack of knowledge. It is our
perfectionist mindset that holds us back. Our mind opposes the thought of an
investment that has risks, because it is against some of the most inherent
beliefs. And that, I believe, is the fundamental reason we are not able to act
upon a good investment opportunity.
Overcoming the Fear
It is quite clear that we need to work on some of our deeply held beliefs.
This can be a bit challenging because our mind has a tendency to reject any opposing
thought. It is important to be open to ideas that challenge our belief systems
because these ideas could unblock new avenues of thinking.
Failure is not as bad as it is made out to be. Not even multiple
consecutive failures. In fact, one big success can make up for multiple failures
of the past. Many stock traders, for instance, operate this way. When they
enter a trade, they have strong reasons to believe that the price will move in
their favorable direction. They know what percentage of their account size will
be at stake. They also will have determined the levels at which they will take
their profits or cut their losses in case of a negative outcome. Thus, the risk
and reward are known. A good risk-reward ratio makes it possible for a success
to make up for multiple failures.
Now here is an example of how a calculated risk can be used to get ahead:
Imagine that you are appearing for a competitive test, where every question
has 4 answer choices, out of which only 1 is correct. A correct answer gets you
+3, a wrong answer gets you -1 and an unanswered question gets you 0. Now
suppose for a particular question you were able to confidently eliminate 2
answer choices (say A and B), but you are stuck between the other 2 choices (C
and D). So, each of the remaining choices has a 50% probability of being
correct. The risk-averse perfectionist mind will tell you not to attempt it,
because you are not 100% sure of any answer.
Should we take a calculated risk here? Let us do the math:
Let us assume this is the case with 10 out of 100 questions in the test. In
each of those 10 questions, having eliminated 2 choices, we pick one answer
choice (out of the remaining two) randomly and mark it as our answer. As each
choice had a 50% probability of being correct, we can assume that 5 of our
answers were correct and the other 5 wrong. So how does this affect the total score?
15 marks for the 5 correct answers, and -5 for 5 wrong answers. Net impact: +10.
So a candidate who takes calculated risk here would get 10 points more than the
risk-averse competitor, who had just the same knowledge level!
In fact, even if only 3 answer were right and 7 wrong, the net effect will
be positive (3*3 – 7*1 = 2). So, all you need is 30% success and you know the
success probability is 50%. Therefore, this can be considered as a risk worth
taking.
Some points to bear in mind while taking the risk:
- Do the calculations carefully. In the above example, if the scores for a correct and a wrong answer were +1 and -1 respectively, our calculations will change, and so will the conclusion. So make sure you don’t gamble.
- Be aware of the maximum loss. It should be bearable. It is not advisable to put all the savings of your life into an investment that has considerable risks. Arrive at a suitable amount after considering the amount of risk involved and factors pertaining to your personal finance.
- Ensure the risk-reward ratio is favorable i.e. make sure the reward well exceeds the risk.
Before I conclude, I would like to tell you that despite having done the
entire calculations well and most factors being in your favor, you can never
completely rule out losses. In our example, we cannot completely eliminate the
possibility of the candidate getting all 10 answers wrong and scoring -10
instead of a safe 0. But will you be content with that safe zero? There are
people, who are not ambitious with their finances and choose to just be where
they are. Such people should stay away from risks. But there are also others,
for whom not having been gung ho after their dreams is far more regretful than
the worst possible loss.
If failure is the pillar of success, it is quite funny that many of us
avoid success fearing its pillars!
Sometimes, we end up with several consecutive
failures, which can be discouraging. But it only means that we are building
strong foundations for a really huge success, that’s how I see it.