Risk vs Return
Risks and potential returns vary greatly from investment to investment. Shares (also called Stocks or Equities) offer you growth, but they can be volatile. Bonds provide you with a steady income and can also provide you with some growth although they come in varying risks which are usually proportionate to return. Collective investment schemes (Funds) can provide you with growth, income or both but are also subject to volatility in the value of the underlying investments and lower potential earnings.
Strategic investing involves allocating your funds in a variety of ways – diversifying among different plans. Once you have evaluated your investment goals, assessed how much money you can reasonably invest, determined your risk comfort level, and learned about your investment choices, you are ready to build a diverse portfolio of investments.
An investment portfolio is the collection of all your investments: all the shares, bonds, cash deposits, property, and so forth. Careful investing involves building a diverse portfolio, one in which your investments are spread over a range of investment choices. Because there is no certainty as to how your money will grow over time, diversifying investments can help protect you when some investments do not perform as well as others.
Investing in collective investment schemes allows you to diversify within a class of investments such as shares or bonds without actively designating where the money should go among these individual investments. Once you make a lump sum investment in a collective investment scheme, a fund manager takes care of spreading that sum among a range of investment options. In exchange for their services, collective investment schemes generally charge you a fee, based on the amount of your yearly assets in the fund.
Individual investors, especially those with long-term investing plans who are willing to absorb market shocks, may feel confident investing a portion of their money in shares. Within the world of shares, there are many ways to diversify as well.
For example, you can invest in:
Blue chip shares – large, established companies with strong records of profit growth that also often pay dividends.
Growth shares – often companies that are just starting out – provide another option. Growth companies, whose earnings are increasing at a rate faster than the industry average, are often smaller companies today, but may not be for long.
You can also diversify your investments in shares by purchasing shares in a variety of industries. Owning securities in a variety of industries offers some protection; when one industry is declining, another may be growing.
After examining the various ways to invest money, you have to decide what percentage of your income you want to invest where. Like the other components of an investment plan, your need for a diverse portfolio may change over time.
|Security Type||Financial Risk||Protection against inflation||Liquidity (how easily investments can be converted into cash)|
|Fixed Deposit||Low – but subject to a penalty if withdrawn prior to the full term of deposit||None||Moderate to low|
|Shares||Medium to High||Good||High|
|Government||Low to Medium||Fair||Varies, but generally high|
|Corporate High Quality||Low to Medium||Fair|
|Funds investing in:|
|Shares, Bonds||Low to High – Depends on skill of fund manager and objectives||Good||High (with exceptions in respect of closed-ended funds)|
|Money Markets||Low risk||None||High|
|Home, Commercial Property||Medium to High||Good Low|
|Art, antiques, gold, etc.||Medium to High||Varies||Low to moderate|
As you determine your investment strategy, here are some points to keep in mind:
- Growth is the rate at which your money increases in value during the time it is invested. If you think you will need your money back sooner rather than later, look for an investment that provides a fairly safe, steady growth rate and which is relatively liquid. High growth investments might be tempting but are usually subject to substantial fluctuations. Long-term investments that are influenced by factors such as the inflation rate may lose money in the short term, but they can still grow over an extended time frame. What will matter is not a slow growth rate (or even a loss) during a particular period, but a higher growth rate over time.
- Yield is the interest or dividends paid on your investment. Like growth, it can vary in importance depending on your needs. If you are retired and your investment is funding your retirement, your investments should generate enough yield to let you live on the interest. Savings or fixed deposit accounts tend to yield small percentages; bonds, on the other hand, can yield higher percentages, but their yield rate is affected by inflation. Equities, and collective investment schemes which invest in equities, can yield the highest percentages but also have the greatest chance of loss.
- Closely related to yield, the third factor to consider is income. Does your investment, or the yield from your investment, make up a significant portion of your income? If so, you may want to be more conservative with your investment choices to ensure that the amount of yield it produces remains consistent and reliable. You should give careful consideration to where and how often you want to reinvest your money, as it could effect your financial security. If you are retired, your investments may be your primary source of income and it is generally more important that you select investments that produce income rather than growth.
- The fourth factor to consider is risk. Simply put, risk is the possibility of losing some or all of your investment. Each investor has a different risk tolerance. If you are a conservative investor, you should probably seek opportunities that offer safety and some measure of control over your return. Conservative investors may choose to miss some high-growth opportunities by keeping their money in investments with more secure rates of return. On the other hand, aggressive investors will take some chances with a volatile, or fluctuating, market in the belief that they have the opportunity to receive a greater return on their initial investment. Of course, there are investors who fall in between conservative and aggressive; they may choose to invest partially in conservative outlets and invest other funds in riskier ventures.
For personal investing, you need to determine your own comfortable level of risk and select investments that match. Investors should always seek professional advice from an Independant Investment Advisor before taking a decision on an investment.