7 Risk management
This chapter covers
- Classifying risks
- Mitigating risk
- Hedging strategies
- Optimizing your portfolio using the Markowitz model
- Assessing non-financial risks
Exploring assets that can multiply their original value many times is thrilling. However, if you stake your life savings on extraordinary profits, you might find yourself sleepless at night, questioning whether you abandoned your common sense the moment you made that investment.
In our minds, we can picture the stereotype of a gambler who seeks the thrill. However, we can also envision a stereotype of a risk-averse investor: a dry person who lectures us on efficient market theory and continually advocates for putting all our money into diversified ETFs. They occasionally insist that investing in single stocks with low-risk ratings is too risky. Encountering them when you dream about living in a big mansion with the potential returns can feel like a slap in the face. No matter how enthusiastic we are, they always have an explanation for why things won’t unfold as we hope. Whether it’s human bias, statistics about fund managers and their historical returns, or something else, the recommendation remains the same: you cannot beat the market, so invest in it by buying shares in index funds.