Lots of people out there will like to tell you investing could be risk free. But that’s a lie. A lie that many well intentioned people fall prey to everyday. Without this lie, so many people will not fall victim to Ponzi schemes and related investment frauds. All investments come with an inherent quantity of risk. As much as some risks can be insured, there’s a limit to what insurance companies are willing to take. Even at that, there is the risk of the insurance and reinsurance companies defaulting. Hence, all investments come with risk.
As an investor or a potential investor, it will be best if you understand the extent of the risk you can take and how it can be used among other inputs to help make the most for you. At Genie Capital, we try our best to understand our investor’s objectives, risk tolerance and other variables so as to know how best to guide in their investing journey.
Definition of Risk
Wikipedia has a simpler definition of Risk, which is the possibility that the actual return on an investment will be different from its expected return.
At Genie Capital, our working definition of Risk is the probability that the expected return of an investment will be different from the actual return of the investment.
When we invest, we are making a bet about the future. A future we believe will favour us and give us positive returns. We are hoping. We are hoping if everything turns out good, we should at least get the returns we are expecting. If the outcome was too good, then those returns should be far greater than what we expected. If however, things went sour, then the actual returns should be less than what we expected. If things turned out really bad, we could actually lose some or all of the capital we invested.
If given enough time, we will like to measure the probabilities of each and every outcome and how that differs or matches to the investor’s expectation. An investment is said to be risky when the variability between the expected and actual returns is high. An investment is said to be less risky when the variability between the expected and actual return is low.
At the heart of Risk is the variability inherent when comparing two states - the actual and expected states of return on investments.
Relationship between Risk and Return
There is an adage “No risk, no return.” Others say “Nothing ventured, nothing gained”. Both expressions convey the idea that the higher risk one takes, the higher the return they should be expecting. Does this expectation match reality? There is a lot of empirical evidence that risk is positively correlated to returns over the long term, whereas in the short term there is no correlation between risk and return.
Positive correlation between risk and return in the long term:
Numerous studies have established that in the long term, there is a strong positive correlation between risk and return. Remember, in Cameroon, we define the long term to be more than 10 years.
In layman’s terms, that means those who make risky bets and stick to their bets over the long term tend to have higher returns. What actually happens is that most of the bets will fail. But the few that succeed will be so great they will cover for the failed bets and give a lot more returns.
For instance, an investor who invests in startups, generally considered high risk investments, may lose on about 90% of the startup. However, 1-3% of the startups may return more than 100x while the remaining 7-9% may return less than 3x but more than 1x. Some startups may actually lead to 10,000x or more. Making the investor a billionaire “overnight”.
Zero correlation between risk and return in the short term:
Numerous studies have been carried out which established that there is no correlation between risk and return in the short term. In Cameroon, when we talk of the short term, we should be looking at less than 5 years. And we are referring to investing, not running a business.
What this means is that for those who invest and waver, most often the risk they bear never leads to the commensurate returns. Short term investing usually leads to excessive trading in search of better opportunities, more trading and so forth, such that the investor does not benefit from the compounding of the investments as a result of the accumulated learning and development of the underlying companies.
If you want to reap the rewards from the adage “High risk, high returns” then you will have to invest in the long term. Taking higher risks in the shorter term may not necessarily lead to higher returns.
According to Investopedia, Risk Tolerance is defined as the degree of variability in investment returns that an investor is willing to withstand in their financial planning.
Risk like pain does not affect everyone the same. There are certain people who can absorb more pain before crying or breaking, whereas there are others who just a little pain breaks them down. We can say the same thing with Risk. Some people can withstand more risk, others not that much. The amount of risk an investor can withstand at any given point in time is considered the investor’s Risk Tolerance.
One’s risk tolerance depends on a number of factors, including but not limited to:
- Stage of life
- Income level
- Family situation
As the underlying factors change, so too does one’s Risk Tolerance.
Spectrum of Risk Tolerance
There’s a broad spectrum of Risk Tolerance with the two extremes being Very intolerant and Very tolerant. From those two extremes we have Intolerant, Neutral and Tolerant.
The investor who is Very Intolerant with Risk is the kind who does not want to have any variability in their expected returns and actual returns. Such an investor wants to be promised 1.05x and receives 1.05x only. Such an investor is not interested in any variability even if it means the possibility of higher returns. Traditionally, such an investor will be proposed a Conservative Investment Portfolio - whereby they are exposed to the least risks and most often their investment is protected.
The investor who is Intolerant with Risk is not as strict as the investor who is Very Intolerant with Risk. However, such an investor can take very minute variability between expected and actual returns. For example, if the promised return is 1.05x, the investor could be comfortable with 1.048x to 1.052x. Anything beyond that range will be intolerable. The traditional Investment Portfolio is Conservative and to a larger extent such an investor wants protected investments.
The investor who is Neutral with Risk does not actively pursue risk, but they do not actively find means of protecting themselves against risk. Such an investor will place bets that have mild risk inherent in them and are willing to take on some variability, but they will not allocate any funds to cover up for the mild risks taken. Traditionally, such an investor is proposed a Moderate Investment Portfolio.
The investor who is Tolerant with Risk actively pursues risk with the hope of increasing the probability of their returns. Such an investor will place bets that could have a lot of variability between the expected returns and actual returns. The traditional Investment Portfolio proposed to such an investor is often termed Aggressive.
The investor who is Very Tolerant with Risk actively pursues risk with the hope of increasing the probability of their returns. They are very comfortable with wild swings and have little or no worries when things turn out bad.
As an investor, it is paramount to know where you fall on the Risk Spectrum. While understanding one’s position on the Spectrum is important, it is much more important to have a good idea of the Risk of every investment anyone is supposed to be making. When, as investors, you ask for the actual risk of potential investment opportunities, the promoters will have no choice than to seriously consider the true risks of their projects instead of the blanket lie that it is risk free.
About Genie Capital
At Genie Capital we identify, develop and invest in opportunities, technologies, IPs, processes, etc that deliver superior long term returns to our investors, whether they're investing in Real Estates, SMEs, Stocks, Bonds or Crypto Assets.
We have a mission to help build the financial infrastructure of Cameroon that will enable Cameroonians to directly invest in and benefit from the development of the country, rather than leaving it to foreigners who might not understand our needs and aspirations.
Though the concepts that are the foundations of Genie Capital have been in the development since 2013 or so, the company was incorporated in Limbe in July 2021 with head office at Mile 18 Junction, Buea - Silicon Mountain, SW - Cameroon.