Risk in Investing

What is the most I can lose on this investment? This is a question that almost every investor who has invested or is considering investing asks or should ask at some point in time.

When you invest, you’re exposed to different types of risk. Given how fundamental risk is to investments, many new investors assume that it is a well-defined and quantifiable idea. Unfortunately, it is not – there is no single measurement or scale on which you can measure risk.

The general rule is, at low levels of risk, potential returns tend to be low as well. Alternatively, a higher level of risk means you should be seeking a higher level of return. Every investment has different levels of risk and return.

An accepted finance definition for risk is ‘the degree of uncertainty and/or potential financial loss inherent in an investment decision.’

Investment risk can be defined as “the possibility that your investment may fall in value or earn less than expected.” (ASIC MoneySmart).

I view investment risk as ‘the risk of permanent loss of capital.’ A poor-quality investment can experience decreases in value and never recover.

A more commonly accepted measure of risk is the volatility of the investment – how much the value of an investment moves up and down over time. An investment with larger swings in its share price would be more volatile, and thus perceived as riskier.

I see risk as a component of time – the longer you hold a good investment the less its volatility matters. A carefully researched investment can still fluctuate in the short-term and generate a negative return. I am more confident that over time the short-term price volatility will be smoothed out by its growing earnings steam, and the price will rise above the price it was purchased for.

You can reduce investment risk by:

  • Invest long-term rather than short-term. Short term trading is not investing – investing is about minimising risk to generate wealth over the long-term, not making short-term profits. As Warren Buffet has said, “If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes.”
  • Having a reasonable diversified investment portfolio enables you to be less exposed to a particular industry, political or economic event.
  • Learn about investing. Knowledge is power – the more you know about something the smarter and safer your decisions will be.

Overall, the better you study, understand and know your investment will reduce its risk. When I search for high-return investments, I am conscious of the risk of permanent loss of capital. That risk needs to be very small in relation to the potential return.

As Peter Bernstein stated in Against the Gods: The Remarkable Story of Risk, “the notion of bringing risk under control is one of the central ideas that distinguishes modern times from the distant past.”

If you are in need of any advice about your risk on investment or would like a complimentary consultation, please contact me.

Posted in Investing.