Risk & return

Is it worth the gamble?

Risk is the chance an investment won't give you the outcomes you want. For example, you expect your investment to grow but its value falls. Or you expect regular interest of 10% but interest payments fall to 5%. Or you expect to be able to get your money whenever you need it but your managed fund suddenly freezes withdrawals.

It's impossible to avoid all risks when you invest. Higher potential returns usually come with higher risks. The important thing is to understand the risks and then keep within a level you are comfortable with.

Understand risk

Successful investors understand the main types of risk that can hit their investments. If you do, you will have a much better chance of avoiding the 'ouch' factor from taking too many risks.

The specific risks to keep an eye on depend on your needs and the type of investments you make.

Compare with low risk investments

Some investments are low risk. For example, a term deposit or bank account is low risk as the deposit you make is government guaranteed for up to $250,000. This account may offer interest at 4%. Any investment offering a return above this rate has some kind of risk and you'll need to find out what it is.

Short-term savers

If you want to spend your money within 3 years, your main concern will be to protect your capital. A high interest savings account, with an authorised deposit-taking institution is safe and your money will be available when you need it.

The case study short-term saving looks at when 'low risk' is the way to go.

Long-term investors

If you're investing for the long term, say more than 7 years, you want your capital to grow in value. Risks you face include:

  • Inflation may erode the purchasing power of your money (this means that a fixed amount of money will buy less things in the future)
  • The timing of your decisions may cause lower returns or loss of capital (buying at a market peak, selling when the market is down)

The case study capital growth gives examples of how to deal with such risks. 

Retirees

As a retiree you rely on your investments to give you money to live on. You need them to give you regular, reliable income payments. The risks you face include:

  • Your investments will not produce a regular, consistent income. For example, share dividends are usually only paid twice a year and are not guaranteed. Interest rates can go down, reducing your income.
  • Inflation may erode the purchasing power of your money.

The case study regular income tells one retiree's investing story.

Other risks

There are other types of risk that can hurt your investments if not managed properly. Interest rate changes, currency movements and changes in the law can all affect how your investments perform.

Use tactics to manage risk

As a general principle, the lower the risk, the lower the likely rate of return. You'll need to take some investment risk to end up with a healthy return over time.

Your aim is to meet your goals, protect your capital and maximise returns, without exposing yourself to too much danger.

Smart tip

Diversification is a key way to reduce risk. Don't put your life savings into one investment. 

You can do this by:

  • Choosing investments that match your needs and investment timeframes
  • Sticking with mainstream strategies, investment types and providers
  • Diversifying - you'll kick yourself if you lose half your money by putting it all in one place. See diversification
  • Having some of your investments in low risk assets (such as interest-bearing deposits) that you can draw money from when markets are performing badly

You can test your knowledge of investment risk, diversification and investment products by taking our investing challenge. 

Investing challenge

Watch out for investment scams

There are no shortcuts to investing success. The combination of high returns and low risk does not exist. The golden rule is 'if it sounds too good to be true, it probably is too good to be true'.

For more information see investment scams and investment warnings.

Investing is never going to be risk free. With careful planning, you can identify and manage the risks that are most likely to trip you up. Diversification is the best tool you have for overcoming investment risk.


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Last updated: 11 Jan 2016