Why we ignore, overlook or underestimate risks

Why we ignore, overlook or underestimate risks

A retired businessman who successfully built up his businesses, from timber trading to real estate, recounted to me how he was "conned" of millions of dollars by a fund manager.

Over dinner last week, a colleague told the story of another colleague who parted with more than $100,000 of his hard-earned money to invest in an antique trading venture with yet another colleague.

He lost the entire sum.

When we hear of such tales, we usually place the blame squarely on greed.

Yes, in certain cases, greed is the culprit. But there are a lot more factors at play which may cause us to make less-than-wise decisions.

Naivete is one.

Naivete is defined by The Free Dictionary as the state or quality of being inexperienced or unsophisticated, especially in being artless, credulous or uncritical.

There is no lack of get-rich-quick schemes out there: those advertised in the papers; those brought to us by friends and relatives, or even strangers we met on the street or online; those recommended by private bankers who put their commissions above their clients' interests.

If one is credulous and not critical, and perhaps a little greedy, then one could very easily fall prey to bad investments.

How to counter naivete? One good way is to talk to friends who are investment savvy on the soundness of what one is about to do.

One should also carry out one's own due diligence.

Do your research on the Web to find out the experiences of others who have participated in the schemes.

Be sure to get your information from independent websites and not "testimonials" provided on the scheme providers' websites.

Read up on how the scheme makes its money.

Make sure that it is legitimate and it makes good business sense.

Always understand what you are putting your money into, and know what could cause you to lose your capital.

It is useful to keep a few common sayings in mind: "If it's too good to be true, it probably is" and "There is no such thing as a free lunch".

But naivete cannot explain why the retired businessman handed over millions of dollars to the so-called fund manager without proper due diligence on the fund management company, or how Mr Oei Hong Leong purportedly lost some $1 billion from foreign exchange and United States Treasury bond transactions.

I put that down to complacency and overconfidence.

We get complacent and overconfident when we have had a few positive experiences.

In the retired businessman's case, his initial few investments with the fund manager yielded lucrative returns.

He got back his capital plus a fat return in a short space of time.

That increased his trust in the fund manager and caused him to let down his guard in his subsequent dealings.

As for traders, a string of successful trades tend to boost their confidence.

A couple of things happen when we become complacent and overconfident.

One, we put the amount we raise at risk.

Worse still, if we borrow to bet or invest.

Two, we may begin to skip some of the steps in the process which made our first few investments successful in the first place.

When we bet big, or when we skip some parts of our due diligence process or analysis, or when we relax some of the criteria for our investments, we are taking on more risks.

Hence, for every investment that you make, always ask: What is the risk to my capital? What could go wrong? What is the damage to my overall financial health if this deal goes awry?

Mr Warren Buffett, one of the most successful investors of all time, has two golden rules in investing. Rule No. 1: Do not lose your capital. Rule No. 2: Do not forget Rule No. 1.

Next week, we will talk about what makes some risks toxic and how to manage them.

And to clarify a point made in last week's article, the deferred annuity will pay out $41,000 annually on the initial sum of $300,000 paid 10 years ago, or the guaranteed surrender value of $475,000 now.

The payment will be for a minimum period of 10 years, or for as long as the life insured is still alive.

In other words, the annuitant will get back the full $475,000 in under 12 years. Unfortunately, annuities in the market today do not provide as generous a payout as before.

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