Risk and return
Different types of investments have different risk profiles. As an investor, you’ll come across the terms ‘risk’ and ‘risk profile’ a lot.
Risk is the possibility of losing some or all of your original investment. Often higher risk investments offer the potential for greater returns however there is also a significantly increased potential for loss. How you feel about it will depend on your individual circumstances, your investment goals and timescales, and even your personality.
How comfortable are you with risk?
Accepting that it is most unlikely that the outcome of the two scenarios will be exactly the same, how would you respond to the following two statements?
‘There is an 80% chance this investment will make money’ vs ‘There’s a 20% chance this investment will lose money’.
These two statements describe exactly the same investment risk – they’re designed to get you thinking about how you view your money. They also show that your attitude to risk can depend on the amount of risk you’re faced with.
For example, if you have a large sum of money to invest, you might be happy to take more risk than someone with only a small amount. Then again, if you’ve got less money, you might be looking for greater returns and prepared to take more of a risk. Or then again, you might feel uncomfortable with the idea of losing any money at all. In which case you might want to stick with cash based savings products. So risk really does depend on your individual circumstances and investment goals.
Remember, all investments carry risk
As a general rule, greater risk equals greater potential returns. But nothing is guaranteed and you could lose some or even all of your money whatever the level of risk.
Risk also depends on the type of investment. For example, funds that hold bonds tend to be less risky than those that hold shares, but this is not guaranteed. And there are always exceptions – e.g. an emerging market or high-yield bond fund is likely to carry greater risk than a fund that invests in shares of large companies from the UK, US and Europe. The golden rule? Always do your research.
Can risk be managed?
Nothing’s guaranteed, but you can aim to manage risk by investing for the long term and by diversifying. It’s also sensible to pay money into your investment regularly, rather than all in one go. This can help smooth out the highs and lows of the market and cut the risk of making big losses.
Funds - a type of investment where a professional investment manager takes the money paid in by lots of individuals and invests it in a wide range of assets, e.g. shares, bonds etc. Each fund has its own objective and the money is invested accordingly.
Bonds - when you buy bonds, you’re effectively lending money to a government or company to fund spending or raise capital.
Shares - companies divide their capital into units called shares. When you buy shares, you buy a stake in the business and could earn dividend income, although like all investments you could lose money.
Emerging market fund - a fund that mainly invests in countries with developing economies, e.g. China, Eastern European or South American countries, and which are likely to carry a higher risk of losing money than other mainstream investments.
High-yield bond fund - a fund that invests in corporate bonds issued by more risky companies and in return offers a higher rate of interest, coupled with a greater risk of losing some or all of your money.