At some level, all investors consider capital preservation when they make an investment. Capital preservation lies on one end of the risk continuum, while investments that put all your capital at risk generally offer the highest possibility of reward.
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Inventory – Low Risk
If your business invests in inventory, this represents a generally low-risk scenario. The time frame between getting inventory and turning it back into cash is relatively short. Furthermore, if your inventory is not selling like you planned, you can discount it and preserve most of your capital. The upside of selling all the inventory is meager and the downside risk is also minimal. Investing in inventory is like buying a bond.
Production Equipment – Medium Risk
A more risky investment might be using your capital to develop and build new production equipment. The time horizon between investment and return is much longer than with the previous example involving inventory. Also, you run the risk of building a new product that no one wants. If this is the case you can sometimes sell the equipment for scrap, or try to repurpose it to preserve at least a small fraction of your capital investment. Investing in production equipment is like investing in public stocks.
Innovation – High Risk
Finally, on the far end of the continuum is investing in a new innovation or research and development. Such an investment often takes years to get to market. Also, since most of the effort has no tangible assets if the innovation fails the investment is generally a total loss. However, successful innovation often has huge payoffs. Investing in innovation is like being an entrepreneur and investing in a new start-up business.
In the end, generally, the more you try to preserve capital the less the ultimate payoff will be.
Where do your investments fit on the risk continuum?
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