Have you ever come across the phrase, “potential gains are worth the potential losses?” If so, it might have been in the context of asking whether or not you agree with the statement. For example, companies sometimes ask potential employees to fill out psychological quizzes that have statements such as this one. You answer how much you agree or disagree and it’s supposed to say something about your psychology. It may, particularly about your psychology as it applies to your approach to investing. It’s worth taking a look at.
What Does Potential Gains are Worth the Potential Losses Mean?
When you break down the sentence, this statement is really all about risk assessment. Are you will to take the risk to lose a lot if it means that you have the potential to gain a lot?
This doesn’t necessarily have to apply to money. It could, for example, apply to taking a chance on love. Would you be willing to risk the potential losses of heartbreak for the potential gains of falling in love? Or would you rather protect your heart? In other worse, how willing are you to take the risk?
In COVID times, you might assess the risk/reward of taking a trip to see a loved one. Perhaps they’re getting married or maybe it’s the end of someone’s life. Are the potential gains of having that special time with them worth the potential losses of illness? Put the other way, are the potential gains of safety from illness worth the loss of those special times with them?
The fact that the sentence can apply to almost anything is what makes it appealing, and frustrating, on psychological tests. After all, you might be willing to risk it all for love but not for a job or a certain amount of money. And yet, the tests ask you to answer “yes or no” or “on a scale of 1-5.”
If you’re trying to answer the test one a psychological exam, you might just err on the side of caution and answer “3.” This would essentially mean that about half the time the potential gains are worth the potential losses.
Applying the Concept to Investing
When it comes to money psychology, it does truly help to consider how you feel about the statement that potential gains are worth the potential losses. You have to get clear with yourself on what it means for you to take risks with your money. What rewards are worth it to you if they come with potential losses?
At the very basic level, looking at your risk tolerance will help you decide how and where to invest your money. If you hear “potential gains are worth the potential losses” and immediately cringe and disagree, then you probably don’t want to make high-risk investments. You would put most of your money in IRAs, long-term savings funds, and other relatively safe forms of investment. You won’t have the potential for big gains this way, but neither will you risk the big losses. That might feel best to you.
On the other hand, if you hear “potential gains are worth the potential losses” and immediately think, “absolutely!” then you might prefer high risk investments. You might want to invest in cutting-edge finch companies, cryptocurrency, and high risk stocks. Sure, you take the risks of big losses, but you’ve already determined that you are someone who thinks the potential gains are worth it.
When The Potential Gains are Worth the Potential Losses
Your age, stage of life, family situation, and financial influences from childhood, and beliefs about business may all play a role in how you relate to the gains/losses risk/reward.
For example, younger people who don’t have a family to support and who have their whole careers ahead of the may be far more comfortable making risky investments than someone who is older, supporting their own aging parents as well as their college-aged children and coming to the end of their own career.
On the other hand, sometimes an older person has the attitude that “there’s no time like the present.” In other words, life is short and sometimes the big potential losses are worth the gains. That person might quit their steady job to invest in a business that they have a true passion for.
Ultimately, you have to decide for yourself with the potential gains are worth the potential losses in any given situation.
Assessing Potential Gains and Losses
First, you want to know where you tend to generally stand on the concept. Do you lean towards taking risks or avoiding them when it comes to investing?
Once you know that, then the other key component is knowing how to assess for risk. When it comes to investing, there is usually a lot of information available to help you decide.
For example, someone who reacts negatively to the statement “potential gains are worth potential losses” is going to have a low tolerance for risk. They could easily get the assistance of a financial advisor, letting the person know that they want to invest wisely, taking as few risks as possible.
The risk-tolerant person who enjoys seeking out those big gains may, on the other hand, ask their financial advisor to put together a portfolio of riskier stocks.
Many of us are in the middle. We tend to think that the concept itself is too black-and-white for the reality of our world. We believe that sometimes the gains are worth the losses – but sometimes they aren’t. That’s why many of us make mixed investments. We put a small portion of our money aside for high risk investments and use the rest on more conservative saving.
Although a financial advisor can help you assess risk, it’s worth learning enough about investing to do it for yourself. And then, learn to trust your gut.
Other Areas of Money to Apply This Concept
Investing is the primary area where you might want to think about the concept of potential gains are worth the potential losses. But it’s not the only financial area where this shows up. You might also want to consider it when:
- Deciding whether and how much to pay for a college education
- Assessing if you want to borrow money to start a small business
- Choosing whether or not to gamble
- Deciding whether to have joint or separate checking accounts in a new marriage
- Determining whether or not to lend money to someone
Truly, whenever you’re about to make a financial decision, you might want to ask yourself what the risks are. Then ask yourself what the rewards might be. How do you weigh the risks and rewards?
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