Understanding Investment Risk
When setting your financial goals, deciding on the structure of your investment is crucial to managing risk. There are a few things you should keep in mind that can help control risk such as choosing investments appropriate to your time frame, your risk profile and diversifying across assets.
Know your investment timeframe
When you invest your money, you need to set a timeframe, that is, you’ll need to decide whether you are investing to meet short term needs such as saving for a holiday, for the children’s education or investing to meet financial needs in retirement.
If you’re investing for the short term, shares are generally more risky because of stock market volatility. Some of your money could be lost as share prices rise and fall from day to day. You simply can’t predict what you’ll get back at the end of your investment period.
Put your eggs in different baskets
When you’re investing, there are lots of different types of ‘baskets’ to choose from: cash, fixed interest, property, shares (Australian and international). You can spread your money across different countries, individual investments or investment managers.
The idea is to reduce the impact that any one of your investments would have on the total value of your investments, should it perform badly. Assets move in different economic cycles so when shares do badly, bonds or property might do well, or vice versa. This helps reduce risk and increase your returns.
Don’t play it too safe
People nearing retirement often think they should move their savings into ‘safe’ assets. But watch out. In reality, the safe option may turn out to be the risky option. Here’s why. It’s common for people to spend 20 years or more in retirement. History shows that riskier assets that may give better growth in the long run tend to experience more highs and lows in the short term. But over time, risks can diminish and they may do better than lower risk assets.
