The myth
Managing risk is a critical part of investing. Every investor needs to strike a balance between trying to grow their wealth and keeping the possibility of loss to a minimum.
The thought of losing money can be hard to accept if you’re not much of a risk-taker. You might feel as if the less potential risk an investment has, the better it is for you.
The reality
There are a few factors to consider when identifying the right amount of risk in investing. These are your risk profile, investment goals, and time horizon.
- Risk profile
Your risk profile tells you how much risk you can comfortably bear. You can invest in products that carry an amount of risk suitable for your profile.
- Investment goals
You need to match your investment goal to your chosen investment vehicle. When you invest for short-term goals, it’s ideal for you to put your money in short-term instruments.
If you want to start investing for your long-term goals, it makes perfect sense to use long-term instruments. There’s more room to take risks since your investments will have time to grow and recover from any downturns.
- Time horizon
The shorter amount of time you invest, the lower your potential income. The longer amount of time you invest, the higher your potential income.
This is because of the compounding power of time. If you plan to cash out sooner, then it’s best to minimize the risk your money will be exposed to.
What happens when you take on too much risk? At best, you might see higher returns at faster speeds than you would get with less risky investments. At worst, you could lose a lot of money and fail to meet your target amount by the time you need it.
On the other hand, if you take too little risk, your investments might not grow much. You’ll likely need more time to reach your money goal.
Low-risk investments with modest potential returns are also in danger of not growing fast enough to keep pace with high inflation.
Verdict: It depends
You can protect your money by limiting its exposure to risk. However, you should know how this could affect your investments’ performance relative to your goals.
If you want to take the least risk possible, think about how you can keep your goals realistic. If you have a high, non-negotiable target amount, then you might need to wait a little longer to get what you want.
On the flip side, your timeline could be less flexible than your money goal. When the time comes to spend your money, you might have to make do with a lower amount or find other ways to reach your target.
There’s another way to minimize risk aside from strictly choosing the least risky investments. You can diversify your portfolio to spread risk across different investment outlets.
With a variety of assets in your portfolio, one underperforming investment isn’t likely to put your finances in big trouble. Your money will have other means to grow if you make the right choices.
