Understanding Investment Risk

INVESTMENT RISK

The objective of investing is always to grow your capital, and get the best return you can. However, there is a very important element to consider investment risk.  Most investments carry with them the possibility (sometimes high and sometimes low) of you losing money. With equities, the value of your shares can go up or down. So if you invest in equities, you accept the risk that you may lose money. If you invest in bonds, you take the risk that the company may not be able to pay back your initial investment and the agreed interest as well. When you invest in real estate, you accept the risk that the value of the property could fall.

You could decide that you do not want to invest in any of these and keep all your cash in a bank account. But this option also does not mean that you are not taking any risk. There may be less risk of the value of your capital falling, but the interest you will get on your deposit in the bank will be immaterial compared to the value you could lose through inflation.

There is a direct opposite relationship between risk and reward. The lower the risk you accept, the lower the return you can expect to achieve. However, this does not mean that you should always go for the highest risk option. You should always go with the level of risk you are most comfortable with, keeping in mind your investment goals, how long you are prepared to wait for your investment to grow, and how much of your investment you are prepared to lose.

MANAGING RISK

The best way to manage risk is by ensuring that you spread your investment across several companies, asset classes, sectors, and maybe even countries. By placing your capital in different companies, you ensure that if the value of one company drops, the loss may even be offset by good performance of another company.

By investing in different asset classes, you are also able to spread your risk to take advantage of high returns in one asset class and shield yourself against losses in another as the financial environment changes. The same goes for sectors and countries.

Remember that all investments even the ‘safest’ ones involve a degree of risk. So make sure you choose a range of investments that best suits you.

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Last Update: June 19, 2017  

November 25, 2016   653    New To Investing  
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