What is risk versus return?

Investing can be a highly effective way to grow your money and build a foundation for the life you want to create for yourself.

It’s also important to be aware that investing is not a risk-free strategy and there’s always a chance you could lose money or not make as much as you expected.

All investments carry some risk due to factors such as inflation, tax, economic downturns and drops in particular markets.

Different types of investments carry different levels of investment risk, and also different returns. As a general rule, the larger the potential investment return, the higher the investment risk.

Cash provides lower returns and a lower risk of loss, while growth investments such as shares may provide higher returns and are higher risk.

Managing investment risk

While taking on any kind of risk can be a scary prospect, there are four key strategies you can use to minimise your exposure to investment risk:

• Timeframe: The longer you stay invested, the less investment risk you are exposed to because fluctuations in the value of your investment will even out over time.
• Tolerance: If you’re not comfortable with a certain type of investment, or a certain level of risk, it’s not worth investing in that product.
• Diversification: Spreading your money across different types of investments rather than relying on one asset class may help shield you from drops in particular markets and deliver more consistent returns over time.
• Knowledge: The more you understand about investments and financial markets, the better you’ll become at selecting investments that are appropriate for you.

Gauging your risk tolerance

How much risk you are willing to take on will depend on your situation.

For example, if you have been saving for retirement and only have 12 months to go before you reach your goal, you would probably not want to risk losing the majority of your money.

In this case, it would make sense to ensure you had an appropriate mix of defensive or conservative investments to protect the bulk of your money so you can access it in 12 months, while keeping a portion in growth investments for the years to come.