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Risk Aversion Vs Risk Tolerance: Selecting the Right Strategy

One of the biggest mistakes you can make as a note investor is buying a note without truly understanding your own risk level. 

Most negative feelings surrounding investment come from unexpected gains and losses from an investment that was not well researched. We’re going to talk about some of the risk factors of investment and how to assess if they are too much for you.

Before investing in notes at all you need to understand risk aversion vs risk tolerance and choose your note investments that reflect your personal preferences. Generally speaking, the higher risk — the higher the reward and the lower the risk — the lower the reward.

Risk can sometimes seem like a ‘scary’ word — but it doesn’t have to be. Let’s take a deeper look and find out if you’re open to risk, or keener to play it safe. What are investor risk aversion and risk tolerance?

Risk tolerance describes how much change you’re willing to accept in your investment returns – i.e., a Speculative Investor. The more tolerant of risk you are, the less it concerns you if your investment value takes a sudden dive.

Risk aversion refers to an unwillingness for variation in returns – i.e., a Value-Based Investor. Risk-averse investors would prefer to know their money remains relatively stable over time while it’s invested.

Let’s put risk aversion vs risk tolerance into context.

Options for risk-averse investors. What is a risk averse note investor? If you are risk-averse it’s important to remember investing will always involve some degree of risk. You cannot eliminate risk but you can minimize it. The whole point of investing your money instead of leaving it under your mattress is that you are trying to create value from it. 

As a risk-averse investor, you may be interested in putting the majority of your funds in things such as true performing individually held seller financed notes secured by residential properties. Other options might be a high-yield savings account, CDs, or government bonds. 

You can also reduce risk by investing over a shorter period. Short-term investments say a smaller balance note with less than 5 years remaining or a 60-month partial (you know I love those partials) that let you cash out quickly are a good way to test the waters of an investment type before going long.

Another way to reduce risk is through diversification. Investing in one note exposes you to greater risk than having hundreds of different investments. As time progresses you might have a mixture of different notes such as performing notes in different areas and states, a residential note, a commercial note, a land note, a re-performing note, a non-performing note, etc. – the more note investments you have, the less it impacts you if one goes bad.

Options for risk-tolerant investors. When kept within reason, investors benefit greatly from a little risk tolerance. Risk tolerance has a wide range of levels and tends to vary based on the percentage of savings invested. You’re much more likely to feel okay with a risky investment with a 5% chunk of your savings than 50%.

A risk-tolerant investor would want to put their assets into a range of more volatile assets with a higher potential for return. For example – re-performing notes, non-performing notes and junior position notes. Other options might be stocks, cryptos, business ventures, etc.

The very basics of how to measure the risk of an investment – whether you’re investing in a note, fund, stock, or other type of asset, you should be able to find out types of investment risk and core financial data about it through your own due diligence. Although past performance does not guarantee future success, it can give you a rough idea of how volatile an asset is.

It has good security. Another good indicator is checking the security or collateral that the investment is tied to, if any. Is it a residential property, commercial, land, mobile home, structured settlement, annuity, other or is there not enough security or is there none at all?  

You can also assess risk by assessing your own understanding. Could you explain what you’re doing to a five-year-old? Or does it hide what it’s doing through overly complex language. 

Do your own research and due diligence. Some note platforms, boards, exchanges or products may lure you into a false sense of security, making the note investment process feel like a game. This is the trick used for scams and Ponzi schemes from the beginning of time.

Think about what your own personal risk tolerances are and know this before you invest in anything. Are you Risk Averse, Risk Tolerant or a mixture of the two depending upon the type of investment? 

Know and understand that every individual’s risk level is different, unique and their own. Don’t invest in anything because someone told you it was a good investment. Do your own due diligence and make up your own mind. Be kind, keep safe and stay healthy. Remember success demands action, keep on marketing, it’s going to work! TWITA! (That’s What I’m Talkin’ About!)

Jeff Armstrong of Armstrong Capital has been a note investor and broker specializing in the performing seller financed note industry since 1991. For more updated and current information on how he can help you with your note business, note investments, note appraisals or to request pricing options on a note visit www.armstrongcapital.com to email him and subscribe to Jeff’s Weekly Training & Tips Newsletter. You can follow him on Instagram and Facebook @ TwitaJeff

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