What is risk?
In simple terms, investment risk is the potential for the return on an investment to be less than you expected – this encompasses losing all or some of your original capital, as well as making less profit than expected.
Different investments are exposed to different types of risks, with the more common including:
The above is not a comprehensive summary of all potential risks involved in an investment, and it's important to investigate the potential risks involved in any asset before you make an investment decision.
Risk vs. reward
When thinking about investing, it's natural to consider the potential downsides; many new investors instinctively view risk as negative, and something to be avoided. While it is prudent to protect yourself, it's also important to understand the relationship between the risk you choose to take on, and the returns you may potentially make.
At a basic level, the relationship between risk and reward is direct: the more risk you take, the higher your potential return. This is because the market is compensating you – through the potential for higher returns – for taking on the risk of your investment losing value.
It's important to be clear that higher risk does not necessarily equal higher returns; instead, higher risk gives you the possibility of higher returns. Nothing is guaranteed, so this means higher risk also carries a higher potential for losses.
Ways to manage risk
In order to earn a return on investing, you must take on risk. Savvy investors look to strike a comfortable balance between risk and the returns they are looking to achieve, managing their portfolio in a way that minimises the chance their portfolio will lose value. Some ways you can manage investment risk within your portfolio:
If you are unsure of how to best structure your investment portfolio, and manage investment risk, you could look to a professional adviser for guidance on an appropriate asset allocation.
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