If anyone ever pitches you an investment opportunity but they never talk about the risks involved, run away.  If a financial advisor does not take the time to explain to you the risks associated with different financial options, fire him.  If you are considering starting a new business, but you don’t understand the risks involved in the business, do your homework first.  One of the biggest mistakes people make in their journey to financial success is only looking at the rewards side of the risk-reward equation of the financial decisions they make.

Let’s look at a classic example.  Many people like to go to casinos to gamble.  They go in enticed by the possibility that they will come out ahead and make money by gambling in the casino tables.  Is it possible to take a trip to a casino and make money?  Of course it is.  Many people have done it, and you may have had this experience yourself.  But everyone knows that the odds are against you.  What this means is that even though you may win in the casinos once in a while, if you gamble on a regular basis you will end up losing money in the long term.  The rewards are enticing, but the risks are too high to make gambling in the casinos a good investment activity.

Real Estate gurus have long preached real estate investments as the answer to financial freedom.  Many of these gurus have written books and offered overpriced seminars to teach people how to invest in real estate, often as a highly-leveraged investment, with zero money down.  This strategy may have worked for some people for a while, but when the real estate market hit a wall, the damage was staggering.  Many people that followed the advice of these real estate gurus have ended up owing more money than the houses they purchased are worth, resulting in foreclosures, and even bankruptcy.  The problem is that the real estate gurus pitched real estate as a riskless investment, when in reality real estate has risks just like any other investment choice.

The stock market has historically been the best investment vehicle available.  But as we all know too well, it has its own set of risks.  Does that mean you should not invest in the stock market?  No, it simply means you need to understand and minimize the risks.  You can reduce the risk of your stock market investment by diversifying your portfolio.  This means that instead of only investing in a single stock, or in a handful of stocks in a similar industry, you should invest in several stocks across several industries, with different market capitalizations, and across multiple geographies.  A 100% stock investment portfolio is probably not appropriate for most people.  But an investment portfolio that has a risk-adjusted mix of assets, including stocks, bonds, cash and commodities can provide most of the rewards of a stock investment strategy, and yet reduce the risks significantly.

If you want to start a business, understand the risks involved.  It is a well-known fact that 90% of all new businesses fail within the first five years.  However, you can increase your chances of success by doing a few of the things that few entrepreneurs do well.  Study your market and your potential customers first.  Get experience in the area you are looking to start a business.  Make sure you have the right amount of capital to have a good chance of success.  Most importantly, if you have financial responsibilities such as a mortgage to pay or a family to support, have a plan B just in case the business does not go as well as you are hoping for.  This could mean having your spouse work a regular job that provides a regular income and health insurance while you pursue your entrepreneurial dreams.  It could mean starting it part-time.  Or it could mean having enough savings to rely on if you need it.  Again, the key is to understand the risks and having a strategy to minimize them.

Many people get caught up in the rhetoric of hope.  While hope is important, it is not a strategy.  A well thought-out strategy takes into consideration both the rewards and the risks of every financial decision or pursuit.  So the next time a financial guru starts selling you on your hopes and dreams don’t get caught in the emotions.  An objective analysis of the risks and rewards will always result in the best decisions.