Overestimating Risk.

In the 2007 bull market, investors clearly underestimated the risk of financial instruments they were buying. Share prices of mid cap and small cap companies sky rocketed, as also real estate.Investors were not understanding the risk they were actually taking in.

Now, after a severe bear market, the opposite may well be true. Investors are fighting shy of taking any risk. It appears that the recent financial crisis may have changed saving and investment behavior. The discovery that the world is more uncertain than earlier thought of, may have resulted in a preference for more liquid savings and fewer risky investments.

A generation of investors grew up with two financial crisis periods – the 2000-2001 tech bust and then the 2008-9 bear market. This generation may have developed an aversion to risk, having seen how terrible the consequences of financial crisis can be.

Now, awareness of risk is good, because it ensures due diligence and allocation of capital to more desrving assets. But, fighting shy of taking risk is also a recipe for below average returns. All said and done, risk is what brings higher returns. Just be prudent.