Insights into Housing Market Crash & the Risk-Reward Principle

Years ago, I saw a movie that depicted the dip in the housing market in the United States. The movie starts by describing an investor who noticed a facade in the financials of the housing market. He noticed that certain parts of the housing loans were flukes, and it was only a matter of time before the market crashed. He analyzed the market and decided to bet against the market. So, he took out money (lots of millions of dollars) from several of his clients and placed a trade against the housing market. The banks thought he was crazy but placed the trade on his behalf.

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Another investor read about this "mad" investor and decided to investigate. He took a different approach by asking questions from house to house from everyone who took the housing loans. He discovered from his search that the analysis of the "mad" investor was right. So, he also placed a trade against the housing market. He, however, used only a few thousand dollars.

About eight months after the trade was placed, the housing market experienced a huge dip. The "mad" investor and the investigative investor got loads of profit from the trade. The dip brought over a billion dollars worth of profit to the "mad" investor and hundreds of thousands to the customer.

From this movie, you'll see a depiction of the similarities in how several people handle the concept of investments. We see that both investors did a form of analysis on the investment opportunity before putting their money into it. You may wonder why this is so, and the answer is simple - every investment functions on the risk-reward principle.

The risk-reward principle is a straightforward concept. It says that when you risk more on a venture, you'll gain more rewards. On the flip side, the higher the risk on a venture, the higher the volume of money you'll lose. It is a fair system that rules every investment venture. An example is the "mad" investor who put millions of dollars into the trade. As depicted, he made a lot more money than the "investigative" investor, who put in just a few thousand dollars. This principle is the focal point of every investment opportunity and must be considered before making a decision.

As the movie depicted, the two investors had different research processes before making their decisions on the trade. This takes us to the principle of Risk tolerance. Risk tolerance simply considers the level of viability, the amount of risk involved, and the amount to be invested in an investment venture. It is a thorough evaluation of the nitty-gritty of an investment opportunity to ensure you can invest and even the amount you are capable of investing.

In risk tolerance, you must evaluate the viability of an investment venture. This means you must research the venture to be sure it is valid. In the world we live in today, we have several scams parading themselves as profitable ventures. So, you must have a research process to check if the venture you're considering is true, viable, and one that you are interested in.

Furthermore, you must evaluate the risk involved in the investment venture. When you understand the risk in a venture, you'll have to gauge your financial capacity to know how much you can invest. This involves lots of calculations. However, to put it simply, invest the money you can lose. Investments are risks and must be treated in such a manner. Hence, you should invest the amount of money you are willing to lose.

The risk-reward principle gives such a profound outlook on investment opportunities. It puts the pros and cons into perspective. Hence, it will give you the roadmap to easier decision-making.