Understanding Investment Risk and What You Can Do to Reduce It

Investments can take a number of forms. You might invest in a savings account, stocks, bonds, mutual or self-managed funds, cryptocurrencies, real estate, or startup enterprise. In any of these situations, investment risk is the degree of uncertainty and the potential that you may lose money on your investment.

When you invest, different risks can affect your investment returns – business risk, inflation risk, interest-rate risk, liquidity risk, volatility risk, and credit risk to name a few. Moreover, there are many factors that can affect your investment risk tolerance including legal decisions, government policies, technological developments, market conditions, and even environmental factors.

Lower Risk versus Higher Risk

How much loss you can handle within your investment portfolio is what shows your risk tolerance. And this risk tolerance can be different depending on the factors such as goals, timeline, life stage, personal comfort level, and more.

• Low-Risk Investment

A low-risk investment is an investment in which there is a small chance of losing your money. It is an optimal investment choice for you if you’re a novice in the industry, or investing for an emergency fund, or you need to use the money in less than ten years. A low-risk investment might be taken by someone who is risk-averse, one who is disinclined or reluctant to take risks.

In such types of investments, there is higher stability and security but lower returns. Low risk includes investment in cash or government bonds, fixed interest-term deposits, treasury securities, and stable value funds

• Medium Risk Investment

A medium-risk investment in which there is the probability of getting moderate returns with more long-term investments. A medium-risk investment might be taken by someone who is risk-indifferent, one who is comfortable taking only small risks and higher-than-average return.

Medium risk includes investment in property, infrastructure, managed funds, and blue-chip stocks.

• High-Risk Investment 

A high-risk investment is an investment in which there is a large percentage chance of a devastating loss. You can go for the high-risk investment choice if you want to achieve the biggest returns possible in less time. A high-risk investment might be taken by someone who is a risk seeker, one who is willing to accept greater economic uncertainty in exchange for the potential of higher return.

In such types of investments, there is lower stability and security but higher return. High risk includes investment in shares, commodities, currency trading, and derivatives.

Risk-Free Investments – Do They Exist?

While it’s true no investment is fully risk-free, certain investments have extremely low risks that they are considered riskless investments. A risk-free investment is an investment where the return is known with certainty.

These investments provide a certain rate of return and there is no chance of default. Although several investments (such as savings accounts, sweep accounts, and certificates of deposit) meet these requirements, treasury bills are one of the most sought-after risk-free investments. 

Negative Returns

In a nutshell, a negative return is a loss on an investment. In a negative return on investment scenario, an investment loses its value over a measured time period and the investor will end up with less than what he/she initially invested.

For example, if you buy $5,000 of company ABC stock. After one year, the value of the stock has decreased to $3000. So if you sell it for $3,000 now, you have a negative return of 60%.

Growth and Defensive Assets

There are mainly two types of asset classes – growth and defensive assets.

Simply put, growth assets mean higher risk and higher return on investment. In comparison, defensive assets mean lower risk and lower return on investment.

Here are some major differences between the two.

• Defensive assets are usually more stable and less likely to lose money whereas defensive assets are more unstable and the risks of losing money are higher.
• Defensive assets have lower expected returns over the long run, while returns will be higher on the investment over the short term in growth assets.
• Cash and fixed-interest investment are some common types of defensive assets while shares, private equity, and property are popular examples of growth assets.

Risk and Return

In investing, investment risk and return are inversely proportional to each other. The lower the risk, the more modest the expected return – and conversely, the higher the risk, the more ample the expected return.

The reward from an investment is expressed as a percentage and considered an irregular variable that takes any value within a given reach. A few variables impact the type of returns that investors can anticipate from trading in the markets.

Asset Class Risk

An asset class is a broad group of investments that have similar financial characteristics. These investments are traded in the same financial markets and follow the same rules and regulations.

Traditionally, four main asset classes are – cash, share, property, and fixed-interest securities.

Why would I take a high-risk path?

Though there’s a risk of losing money, there are lots of benefits of high-risk investments. Here are some great reasons why you should take a high-risk path:

• Chances of earning larger than normal gains
• Allowed to invest with limited liability
• Easy buying and selling processes
• Earn capital gains and also get paid out dividends

Short-term versus long-term risk

In investment, short-term investment risks are those that are associated with short-term investment and vice-versa. Short-term risks allow you to meet your goals in just a few years and provide access to returns considered safer. While long-term risks are those that you know you’re likely to keep for several years – or even decades – in the future.

How We Can Help?

Get clear on your investment goals and feel more confident about your financial future. We take a long-term, value-oriented approach to investing with the objective of protecting and growing your wealth.

Accumulus has the financial advisors and expertise to help you achieve your goals at any stage of your financial journey. Whether it’s an investment, tax planning, bookkeeping, or business advisory service, we have got you covered.