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All investments involve a degree of risk – even cash in the bank! And all of us have an individual risk tolerance –
some of us are naturally cautious and just don’t like taking risks and others tend to fly by the seat of their pants
and seem to thrive on risk-taking.
So it is important to match your investment risk profile with your personal
risk tolerance, so you don’t end up a nervous wreck! But you also need to realise that low risk typically means lower
returns and high risk typically means higher returns (but also a risk of catastrophic losses!).
What are
the Risks?
There are different types of risk that may affect different investments: - Global Risk:
The 2008 Global Financial Crisis is a recent example of global risk where by the economy of one country can affect the performance
of investments worldwide.
- Market Risk: Stock and bond prices fluctuate, but there is a risk that
you lose money on your investment when prices drop. Most losses are over short term so as long as you don't need to sell
your stocks, your investment will have the chance to recover from price declines and earn you a greater profit. There is also
a risk with timing in that you buy stocks at the peak of the market and sell at the bottom of the market causing you to lose
money on your investment.
- Company Risk: This is the risk that the individual company in which you
invest will fail to perform as expected.
- Bond Risks: Specific to bonds, credit risk refers to the
government's inability to repay principal plus interest to the bondholder. There is also a risk that the value of a bond
may change from the time it is issued to when it matures. The longer the period to maturity, the greater the potential for
price fluctuation.
- Legislative Risk: Whatever laws the government passes today may be extinct tomorrow
and new laws introduced also have the potential to affect investments in the future. Changing Tax laws are the most significant
legislative risk, but other new laws can also affect individual company performances.
- Inflation Risk:
The risk that the rising costs of inflation will outpace the growth of your investment over time, and also the risk that you'll
live longer than your income can support you.
A guide to investments from HIGH to LOW
risk is as follows: But you also need to remember that low risk usually means low return, and that higher
risk investments such as stocks typically outperform other investments in the longer term (say 10 years), but suffer wilder
fluctuations along the way.
Getting the Right Mix
Getting the right mix of investments in
your portfolio is an individual question and depends on personal your risk tolerance, your financial goals and where you are
in your financial planning cycle.
Ideally, your investment portfolio should include a diverse range of stocks,
bonds and cash - and even a mutual fund or two as well – taking note of the following.
- IF you have
a relatively long investment timeframe (10 years or more) AND you want to make some significant gains from your investment
AND you can stomach market volatility…
….then STOCKS should make up a significant portion of your
portfolio.
- IF you have a mid to long term investment timeframe (5-10 years) AND you want to maintain growth
while preserving your capital AND you can stomach some market volatility…
….then BONDS should make
up a significant portion of your portfolio.
- IF you have a mid to long term investment timeframe (5-10
years) AND you want to make steady gains from your investment AND you have no confidence in your ability to make investment
decisions…
….then go with a MUTUAL FUND.
- IF you have a mid to long term investment
timeframe (5-10 years) AND you want to preserve your capital and maintain growth BUT you can’t tolerate much volatility…
….then PROPERTY could be a good investment choice.
- IF you have a short term investment
timeframe and want ready access to your money AND you just want to preserve the money you have AND you have no stomach for
market volatility…
….then CASH is the way to go.
Of course, one of the golden rules of finance
is that you can’t get something for nothing – in the case of investing, that means that you need to spend money
to make money! Many people actually borrow money to invest, which is why it is so important to make wise and informed decisions
about investing.
See a reputable financial advisor or accountant for advice before committing to ANY investment
– and don’t fall for many of the investment scams around.
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