In this series, we’ll look at some common myths and misconceptions related to investing.
It’s a myth that investing must be a high risk endeavour. Risk is relative, though there are always risks involved when you invest.
Risk is why you often see warnings like: “you may not get back what you invest” and “past performance does not equal future results” when looking at a mutual fund, individual stock, or other investment product literature.
However, there are low, medium and high risk investments, so instead of writing off investing as “too risky,” why not explore how risk works and what it could mean for you?
What do we mean by risk?
All investments can be categorised on a scale of risk. At the extreme end of the spectrum, you have high-risk, volatile investments such as derivatives or options.
These risky products are not for the faint-hearted as the value of the original investment can change so fast and so much that you could gain a lot or lose everything. For this reason, it’s rare that an overly high-risk product is the best place to invest all your life savings.
Invest into one of these options and although your investment isn’t without risk, its value won’t typically change drastically up or down over time. But while lower-risk investments could provide a smoother, gentler ride, you have to be prepared to sacrifice some potential for long-term returns.
That’s the big takeaway here: Risk creates the potential for returns.
Think about how much risk you want to take to achieve specific financial goals, like having a long retirement or buying a home and balance that with how much fluctuations in the value of your investment you might feel comfortable with on your journey there.
How do risk and return work together?
Investment providers often blend higher and lower risk investment options into one diversified product. This helps generate the returns you might hope to achieve for a given risk level, while potentially helping the portfolio from hitting too many ups and downs. Different investments can move in different directions as a reaction to market events, so that when the value of one investment is down the value of another one can be up, with the gains potentially offsetting the losses and vice versa.
Whatever your comfort level with risk, there’s an investment out there for you – from the super cautious to the highly adventurous and everything in between.
The key is to understand the risks involved and how they may impact the value of your investments over time, both in terms of potential gains and losses. That way you can make an educated decision about how much risk is right for your financial goal.
What if I want to take no risk?
You might ask, “Why take any risk at all?” Well, in a nutshell, taking a calculated amount of investment risk can give your money greater potential to grow compared to keeping your savings in cash.
A no-risk approach is difficult to manage in a way that keeps up with inflation: as we’ve all witnessed the increase of the cost of living over the years, you may sacrifice security today for insecurity tomorrow. Without an investment strategy that has some risk and return potential, the wealth you enjoy today may not be enough to provide the same lifestyle or purchasing power that you’re hoping for in the future.
Over the long term, a diversified portfolio will most likely provide more return than a safer investment like a GIC. For that to be a suitable option for you to consider, you have to be willing to overlook the bumps in the road, as those bumps are the only guarantee when investing.
The question that you are left to answer is: “How much fluctuation in the value of my investment can I live with without losing sleep?” Once you answer that question, you can set your maximum risk threshold and find the investments that may work for you.
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