Invest with your head, never your heart. No investment is completely risk-free, but some investments carry more risk than others. Generally, the higher the expected return, the greater the risk.
Having some investment risk is important because it can lead to greater income. The real trick is how you can minimize risk without sacrificing returns. But first, what is investment risk? Do I need investment risk? How do I minimize investment risk?
Investment risk is the possibility that you might lose some or all of your original investment or that the investment may not perform as expected. Generally, the higher the chance of a loss occurring, the higher the investment risk and the higher the expected returns should be.
When you invest, you expect to get a return on your money. You’re probably also hoping you’ll be able to buy more with your money in the future than you can today. If so, your return needs to be higher than the rate of inflation.
If you want to take no risk, you can hold on to cash and eliminate risk but your money will be going backwards because inflation will increase the cost of goods and services, so you’ll be able to buy less with your money over time.
Or you can choose a low-risk investment, such as a bank account or government bond when interest rates are low, your returns may not be much higher than the rate of inflation, so you’ll probably be standing still financially.
If you want your money to grow more quickly, you’ll need to take on more risk. This means putting some money into growth assets like shares and property. You will usually get higher returns, on average, over the longer term, but the trade-off is that they may lose value over the shorter term.
Market and economic conditions can change rapidly, but a knee-jerk reaction to change your investment strategy can make things worse. Any investment decision should be based on your long-term investment plans, not short-term market fluctuations. Review your goals and risk tolerance and, if your investment still fits into your long-term plan, you would need a good reason to change it.
Volatility in financial markets can affect your confidence but it’s important to remember the principles of good risk management when it comes to investing. Having a diversified portfolio means you’ll be less exposed to a particular economic event. You can diversify across and within asset classes, industry sectors and geographic regions. If your investment portfolio is well diversified, a fall in the value of one asset may be offset by an increase in the value of another.
Usually when you buy growth investment assets you expect some short-term volatility, so it’s important not to panic when markets drop. Consider whether the assets you hold are still appropriate to achieve your long-term goals.
Look at how market volatility has affected your investment in the past and consider whether there is any information available that suggests any short-term losses won’t be regained.
As assets gain or lose value, the balance of your assets may change and reduce the diversity of your portfolio. If the percentage of any asset strays too far from its target weighting, you may need to rebalance your portfolio. This usually involves selling some of one asset type and buying more of another.
If you need assistance with developing a financial plan or selecting financial products that are appropriate for your risk appetite, it can help to seek professional financial advice.
And finally, beware of scams. When markets are volatile scammers try to take advantage of investors. Find out how to avoid investment scams but generally if it sounds to good to be true, it probably is.
Beware of Nigerian princes!
Laurie Thomson is a retired geologist living in Maple Bay enjoying life after a busy life inthe mining industry.