Managing investment risk

Invest with your head, never your heart

No investment is completely risk-free, but some investments carry more risk than others. Generally, the higher the expected return, the greater the risk.

Here we explain why having some investment risk is important and how you can minimise risk without sacrificing returns.

What is investment risk?

Investment risk is the possibility that you might lose some or all of your original investment or that the investment may not perform as expected. Generally, the higher the chance of a loss occurring, the higher the investment risk and the higher the expected returns should be.

Why some investment risk is important

When you invest, you expect to get a return on your money. You're probably also hoping you'll be able to buy more with your money in the future than you can today. If so, your return needs to be higher than the rate of inflation.

This is how the amount of risk you take on can affect your investment outcomes: 

  • No risk - You can hold on to cash and eliminate risk but your money will be going backwards because inflation will increase the cost of goods and services so you'll be able to buy less with your money over time.
  • Low risk - If you choose a low-risk investment, such as a bank account or government bond when interest rates are low, your returns may not be much higher than the rate of inflation, so you'll probably be standing still financially.
  • Higher risk - If you want your money to grow, you'll need to take on more risk. This means putting some money into growth assets like shares and property. You will usually get higher returns, on average, over the longer term, but the trade-off is that they may lose value over the shorter term.

Market and economic conditions can change rapidly, but a knee-jerk reaction to change your investment strategy can make things worse.

Any investment decision should be based on your long-term investment plans, not short-term market fluctuations. Review your goals and risk tolerance and, if your investment still fits into your long-term plan, you would need a good reason to change it.

How to minimise investment risk

Volatility in financial markets can affect your confidence but it's important to remember the principles of good risk management when it comes to investing:

  • Diversification - Having a diversified portfolio means you'll be less exposed to a particular economic event. You can diversify across and within asset classes, industry sectors and geographic regions. If your investment portfolio is well diversified, a fall in the value of one asset may be offset by an increase in the value of another. Learn more about diversification.
  • Focus on your investment goals - Usually when you buy growth investment assets you expect some short-term volatility, so it's important not to panic when markets drop. Consider whether the assets you hold are still appropriate to achieve your long-term goals. Look at how market volatility has affected your investment in the past and consider whether there is any information available that suggests any short-term losses won't be regained.
  • Monitor your investments - As assets gain or lose value, the balance of your assets may change and reduce the diversity of your portfolio. If the percentage of any asset strays too far from its target weighting you may need to rebalance your portfolio. This usually involves selling some of one asset type and buying more of another. Learn more about keeping track of your investments.
  • Consider financial advice - If you need assistance with developing a financial plan or selecting financial products that are appropriate for your risk appetite, it can help to seek professional financial advice.
  • Beware of scams - When markets are volatile scammers try to take advantage of investors. Find out how to avoid investment scams.

In times of uncertainty and increased volatility, stick to the key principles of managing investment risk and you'll be more likely to make good investment decisions.

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Last updated: 05 Dec 2018