When it comes to investing there are essentially three risks, systematic, unsystematic, and behavioral. A brief understanding of these risks are as follows:
- Systematic risk: is the risk of the overall market. When the entire market rises or falls that is considered systematic risk. A dropping tide lowers all boats theory.
- Unsystematic risk: is the risk of the underlying business or specific investment. Unsystematic risk would be the business has poor sales, or a real estate investment property catches on fire or is vandalized.
- Behavioral risk: is the risk of the individual or individuals handling the investment. It is the emotions of the investor that influence his or her behaviors. Fears, greed, ego, biases are examples of feelings that influence investor’s behaviors.
Systematic risks would seem that they are the most non-controllable to manage for an investor, yet it is what an investor learns or how they manage their behaviors through systematic risk that determines the outcome. If the real estate market crashes and drives all real estate prices downward an investor’s exposure to the systematic event could be based on their prior actions. For example, if the investor owns the real estate free and clear of all debt, so there’s no loan default risk to be concerned with it could minimize this systematic event for the investor.
Most risk management comes down to education and experience. Understanding history, how things work, value, and yourself are keys to managing risks. For example, there are approximately 117 biases that affect human behaviors. Knowing which biases to avoid in specific situations can help you work your way through risks. The more you learn the easier it will be to identify the risk challenges that could occur on the exterior and from within prior to the risk event occurring. When an event does happen this training will help you to operate from a rules based perspective to manage your way through it.