How much risk can you handle?
There are many different reasons for investing and any two people will not have exactly the same objectives. The level of risk that an investor may be willing to accept is an important consideration that needs to be established before an investment is made. Typically, risk is categorised under the following broad definitions:
Tend to prefer investments with low risks. Low-risk investors may be more interested in preserving the capital value of their investment than increasing its value.
A reasonable emphasis is placed on growth investments together with an acceptance that these could go down in value as well as up. Medium-risk investors can tolerate some fluctuations and volatility, but tend to stay away from investments that may dramatically or frequently change in value (either increase or decrease).
Accept a greater risk of a decline in value in return for potentially higher returns. High-risk investors are prepared for the possibility of losing a large proportion or all of the money invested.
Different investments carry different levels of risk
Cash or deposit accounts are often regarded as low risk, but they are by no means risk free, as evidenced during the credit crisis. Inflation, for example, reduces the purchasing power of cash if it exceeds the rate of interest earned, as it increases the value of goods and services over time.
Many low-risk investors choose to invest in bonds or fixed-interest securities. When investing in a bond an investor is essentially lending money to either a government or a company for a fixed term. In return for the loan, these entities pay a fixed rate of interest. The benefit of this type of investment is that the investor receives a fixed income. The risks are that the company or government may default and fail to return part or all of the original investment or the redemption value may be less than the purchase price.
The price of companies trading on a stock market is a reflection of their values as interpreted by supply and demand for the shares by the investors. When investing in a company, the investor is essentially buying a part of that company and its future profits. On the other hand, they also own the potential losses. The risk can be high, especially if shares are owned in only a handful of companies. Investing in the stock market may be more suited to someone willing to accept medium- or high-risk investments.
A way of investing in all these asset classes could be to invest in an investment fund. An investment fund offers a potentially less risky solution than holding a small number of shares directly. Under the supervision of a fund manager, an investment fund pools together money from many investors. The concept is to enable investors to have a diversified portfolio with a stake in a wide range of assets.
Each investment fund has an objective which describes what it aims to accomplish for its investors and how it plans to achieve it. Some fund managers will aim to achieve high returns by investing in riskier stocks, which could result in higher losses. Others are more defensive, seeking reasonable gains without the threat of big losses. However, no matter where they invest, the value of investment funds may go down as well as up.