• Finance – The relationship between risk and return

    Every investment carries with it a certain amount of risk, and when making a decision on where to invest it is important to not only understand the potential returns (profit on your investment), but also the risk involved. Depending on how you look at it, risk can either mean the uncertainty of return or losing the money you invested. It is the price we pay for the potential for growth.

    Typically the greater the risk of an investment, the greater the potential for high returns, and vice versa. Examples of the different levels of risk include the following types of investments:

    Low risk, low return: Money Market
    Medium risk, medium return: Property
    High risk, high return: Stock Market

    When you’re investing, you need to decide what level of risk you are comfortable with, because you don’t want to lie awake at night worrying about your investments. For this reason it is important to understand and accept the risk involved.

    There are various types of risk, these include the following:
    Capital risk: potential loss of the money you invested
    Market risk: potentially selling an investment at a low price
    Inflation risk: the rate of return on your investment is lower than the inflation rate
    Interest risk: a drop in the interest rate of your investment
    Liquidity risk: limits on your access to funds in the investment over a certain period of time.
    Legislative risk: changes in laws and legislation regarding investments that may make certain investments less attractive.
    Default risk: When the institution where your investment is held goes belly-up and fails.

    In many cases risk can be described as the chance that your investment does not achieve the returns you need to meet the financial goals you intended it for. It is for this reason that the different kinds of investments and their associated risk needs to be understood when choosing an investment product that will meet your goals. Some investment products offer various levels of risk that can be applied at different times in the investment’s lifecycle – for instance when saving for your retirement you might want to choose to invest aggressively with high risk, and lowering the risk when you near your retirement age.

    One thing is is very important when it comes to investing is time – the longer a risky investment is held, the lower the probability of losses. In general riskier investments are held for more than five years, and the higher the risk of the investment, the longer the period that it’s usually held.

    Investing your hard-earned money can be a very stressful experience due to the risk involved with investing. The best way to approach it is to your homework, familiarise yourself with the different levels of risk, decide on your goal for the investment and the level of risk you’re comfortable with, then invest mindfully.

    This article was part of a content marketing campaign for a major financial services provider.