There’s no such thing as a ‘no-risk’ investment
Investment risk is an inherent part of the financial market. However, how much risk you should take on isn’t a one-size-fits-all answer. It depends on your individual circumstances, goals, and comfort level with risk. Some people are more comfortable with risk than others. Some are willing to tolerate more risk to achieve their objectives, while others have different tolerance levels for various types of risk.
Understanding investment risk
Before you invest, it’s crucial to comprehend investment risk and decide what risk level you’re comfortable with. The potential returns available from different kinds of investments—and the risks involved—change over time due to economic, political, and regulatory developments and other factors.
Risk tolerance can be examined in a few different ways. One way is to consider how you would feel if your investments lost money in the short term. If the thought of seeing your account balance decrease makes you anxious, you may be more risk-averse. But if you’re comfortable with short-term losses in exchange for potential long-term gains, you may be more willing to take on risk.
Another factor to consider is how much volatility you’re comfortable with. Volatility is a measure of how much prices fluctuate over time. More volatile investments will have bigger ups and downs in their value, while less volatile investments will have slower, steadier price changes.
Stability and slower growth
Some investors are attracted to the potential for big gains from more volatile investments. Others prefer investments that offer stability and slower growth. So understanding your risk tolerance can help you make better investment decisions and avoid taking on too much—or not enough—risk for your goals.
Different types of investment risks
There’s no such thing as a ‘no-risk’ investment. You’re always taking on some risk when you invest.
Here are some of the common types of investment risks:
Your investments can decrease in value, and you may not get back what you invested. Investing in the stock market is typically through shares (equities), directly or via a fund. The stock market fluctuates in value daily, sometimes by large amounts. You could lose some or all of your money depending on the company or companies you’ve bought. Other assets like property and bonds can also fall in value.
The purchasing power of your savings declines. Even if your investment increases in value, you may not be making money in ‘real’ terms if the things you want to buy with the money have increased in price faster than your investment. Cash deposits with low returns may expose you to inflation risk.
Credit risk is the risk of not achieving a financial reward due to a borrower’s failure to repay a loan or meet a contractual obligation. Credit risk is closely tied to the potential return of an investment, the most notable being that the yields on bonds correlate strongly to their perceived credit risk.
You are unable to access your money when you want to. Liquidity can be a real risk if you hold assets such as property directly and in the ‘bond’ market, where the pool of people who want to buy and sell bonds can ‘dry up’.
Currency risk is the potential risk of loss from fluctuating foreign exchange rates when investments are exposed to foreign currency or in foreign-currency-traded investments.
Interest rate risk
Changes to interest rates affect your returns on savings and investments. Even with a fixed rate, the interest rates in the market may fall below or rise above the fixed rate, affecting your returns relative to rates available elsewhere. Interest rate risk is a particular risk for bondholders.
Making informed investment decisions
While it’s impossible to escape risk entirely, you can manage it by diversifying investments over the long term and paying money into your investments regularly rather than all at once. This approach can help smooth out the highs and lows and reduce the risk of making significant losses. Understanding your risk profile is essential to making informed investment decisions and achieving financial goals.