Knowing Your Investment Risks
Written by Sidney McKinnon, Head of Fixed Income, Warwick Wealth
Investment risk can be defined as ‘the probability of returns achieved from your investments being different from what was originally expected.’ Risk is often thought of in a negative context, but it is more the degree of deviation from the expected that creates the most anxiety among investors. The feeling is exacerbated when the results achieved are below what was expected. Many factors affect the risk of an investment, but gaining some knowledge and understanding of these factors will go a long way to achieving the outcome envisaged. Start with the end in mind. What is your investment target or goal? Having something to aim at will shape the investment path undertaken and determine the level of volatility that is acceptable to your circumstances.
Know as much as you possibly can about the investment that you are getting into. Albert Einstein said, “More the Knowledge Lesser the Ego, Lesser the Knowledge More the Ego….”. The less ego attached to one’s investment, the greater the acceptance of the risk involved.
Have an investment horizon. When do you want the investment to mature? Simply investing and hoping for the best as time goes by will merely raise anxiety levels and widen the gap between what is expected and what is ultimately achieved.
Changes in the economy lead to changes in financial markets, which, in turn, lead to changes in stock prices. Economic changes are, therefore, important drivers in financial market risk. Paying some attention to these changes will assist in understanding the market risk of your investment.
There is one type of risk that is often overlooked when investing in financial markets. This is the risk of having your investment returns eroded by the effects of inflation. Aim to receive returns that are at least in line with inflation to avoid the loss of your future purchasing power.
The age old adage of not putting all your eggs in one basket cannot be emphasised enough when managing the risk of your investment portfolio. Ensure that there is sufficient diversification across asset classes to mitigate the risk of a non-performing investment.
A word of caution to those who are retiring, or nearing retirement. The risk of outliving your savings is real and careful planning is required to avoid the effects of what is known as ‘longevity risk’.
Finally, ensure that your investments have enough liquidity. There is no greater frustration than having to hold onto an investment when you wish to sell it, but nobody is willing to buy it from you.
These are but some of the risks factors facing investors. Through some careful planning and disciplined investing, the risk of investing can be minimised and the rewards expected can be achieved.