Why you shouldn’t invest in something you don’t know
The world of investments, access to information, and the ability to diversify have expanded significantly in recent years. However, one of the most common mistakes when becoming an investor is diving into products or markets that are not well understood or seem complex. If the goal is to build wealth, it’s important to recognize that this doesn’t happen overnight, which is why it’s essential to understand why investing in something you don’t know is not a good idea.
Knowing an investment in-depth not only helps avoid unnecessary risks but also improves the chances of success. To resist the temptation to risk money in markets that promise quick and effortless gains, we will analyze in this article why it’s essential to understand the market in which you plan to invest.
1. Knowledge reduces risk
Investing in something you don’t fully understand is like navigating uncharted waters without a map. Knowledge provides a clear view of how the investment works, the risks involved, and the potential rewards. The National Securities Market Commission (CNMV) warns that undoing an investment can become complicated and costly, which is why it’s crucial to know the investor’s profile, be well-informed, and follow the necessary steps when making investment decisions. Likewise, remember that investment is just one component of personal financial planning. So, if we choose this route to grow our wealth, it’s important to take it seriously.
For example, if you’re considering investing in real estate through real estate crowdfunding, it’s important to understand how these projects are structured, what typical return periods are, and what factors can affect profitability. By understanding the fundamentals of an investment, we can make informed, strategic decisions rather than relying on hunches or fleeting trends.
2. The importance of understanding volatility
Volatility is a key factor in any investment, and understanding how it affects your investment is essential for proper risk management. For example, the volatility index VIX, known as the “fear index,” shows the market’s 30-day volatility expectation.
Each type of investment comes with its own set of risks and volatilities. Financial markets are always uncertain to some extent, and investing in products or sectors you don’t understand can significantly increase your exposure to risk. Without solid understanding, you may encounter unpleasant surprises, such as unexpected drops in value or unforeseen losses.
3. Investment fads and the risk of bubbles
Sometimes, investors are drawn to trends without fully understanding the product or market in which they are investing. Popular investments can create a false sense of security, but real value is based on deep understanding. The reality is that these types of investments can be more volatile and unstable, potentially leading to significant losses if the trend fades or the market adjusts.
This was the case, for example, with the tech bubble of the late ’90s. Many investors rushed to buy shares of tech companies without fully understanding their business models, resulting in massive losses when the bubble burst.
4. Professional advice and experience
While staying informed and taking time to learn before investing is important, realistically, not everyone will have the chance to become an expert in finance before choosing the product or market in which to invest. As support, to feel more secure, it’s a good alternative to rely on the experience or advice of experts in the investment field.
When taking risks, you don’t need to follow someone else’s path. Ideally, you should assess your portfolio based on each situation. For example, when young, you might be more willing to take on higher risks than at a more mature age. Similarly, you can adapt it each year as your situation evolves. This isn’t for everyone, which is why professional help is always beneficial. An advisor can analyze each investment project and provide personalized advice.
Conclusion
If you’re someone with a high risk tolerance and little time to stay informed, investing in something unfamiliar might seem like a good idea. However, after the first loss, you’ll realize it’s better to be cautious.
Before taking the plunge, remember to dedicate time to understanding the markets and products you might invest in. If necessary, it’s also worth considering extra support, such as a professional who can ensure you’re making the right decisions to achieve your financial goals.