If you're trying to choose between two options for an investment, this tiny risk calculator will surely help you! You can use it to assess the risks associated with each option and decide which one is safer. Naturally, if you don't mind risk, you should choose the option with the higher return on investment!
Read on to learn how to calculate risk and to discover the applications of the risk formula.
The risk formula
Very often, we tend to over- or underestimate the risks we take. For example, dying in a car accident is statistically much more probable than a plane crash, yet fear of flying is still much more frequent than the fear of driving.
Luckily, there is a way of quantifying risks, especially the financial risks. All you need to do is apply the following risk equation:
risk = probability * loss
The probability refers to the probability of failure. For example, you might invest a certain sum of money in stocks, and estimate the probability of losing as 12%.
The loss, on the other hand, is the damage you need to bear in the case of failure. For instance, if you really lose the money you invest, this cost might amount to $5,000.
How to calculate risk: an example
Let's say you are choosing between two investment options. Option A guarantees to return fifty percent of $2,000 you invested no matter what the market situation is, but the probability of failure is equal to 12%. In the case of failure with option B, you will lose the $2,000, but the probability of loss is lower - only 7%. In the case of success, both options will bring you roughly the same profit. Which one should you choose?
- Calculate the risk associated with option A:
risk = 12% * $1,000 = $120
- Calculate the risk associated with option B:
risk = 7% * $2,000 = $140
- Compare the risks. In this case, it's less risky to invest in option A.
Remember that this risk calculator doesn't take into account the potential profit! If the ROI of option B is much higher, you might decide for it despite the higher risk.
If you liked this calculator, make sure to check out the relative risk calculator, too!