Risk is the probability an investment would not give you the outcomes you want.
For example, you may expect your investment to grow but its value falls or is lost entirely. In another scenario, you may expect regular interest of 10% but interest payments fall to 5%. Or you may expect to be able to get your money whenever you need it but your managed fund suddenly freezes withdrawals.
Your aim is to meet your goals, protect your capital and maximise returns, without exposing yourself to too much danger.
Government of Malta bonds, for example, have very low risk because they are issued by the Government. Bank deposits also carry low risk because they are backed by large financial institutions. With bank deposits you also have the additional protection of deposit insurance on amounts up to €100,000 if your financial institution goes bankrupt. With these low-risk investments, you are unlikely to lose money. However, they have a lower potential return than riskier investments and they may not keep pace with inflation.
Stocks have a potentially higher return than bonds over the long term, but they are also riskier. They are also more response to the general political and economic environment – in 10 days in December 2018 the US stock market fell by over 10%. Shares also carry risks because they have no guarantees and shareholders are paid last if the company is in trouble or goes bankrupt.
What can be done?
- Choosing investments that match your needs and investment time frames.
- Sticking with mainstream strategies, investment types and providers.
- Diversifying – you will kick yourself if you lose half your money by putting it all in one place. See diversification.
- Putting some of your money in low risk assets (such as interest-bearing deposits) that you can draw income from when markets are performing badly.
It is impossible to avoid all risks when you invest. Higher potential returns usually come with higher risks.
Investing is never going to be risk free. With careful planning, you can identify and manage the risks that are most likely to trip you up.
The important thing is to understand the risks and then keep within a level you are comfortable with.
Diversification is a key way to reduce risk. Do not put your life savings into one investment
There are no shortcuts to investing success. The combination of high returns and low risk does not exist. The golden rule is ‘if it sounds too good to be true, it probably is too good to be true’.
Try out Gemma’s risk profile questionnaire to vet your risk appetite.