What are the risks of investing my money?

What are the risks of investing my money? 

All investing carries some degree of risk, but understanding what risk actually means, and the different forms it takes, is one of the surest ways to become a better investor. The value of your investments can fall as well as rise, you may get back less than you put in, and in some cases you could lose your entire stake. Yet grasping the different types of risk, and how to manage them, puts you in a far stronger position.

In this video, you'll learn why risk is so often confused with volatility, when in fact they're two very different things. Equities in particular go through periods of extreme volatility that can keep you awake at night, but volatility shouldn't be mistaken for risk. A genuine risk is something like not having enough money to last your lifetime, or falling short of a specific goal.

You'll also learn about the different types of investment risk. Concentration risk is having too many eggs in one basket. Credit risk is the danger that a company, or even a government, defaults on a bond. Liquidity risk is the possibility that you can't turn your investment into cash when you need to, a real concern for those investing directly in property. Some of these risks are avoidable: concentration risk, for instance, can be managed through a properly diversified portfolio.

But one type of risk you can never diversify away is market risk, also known as systematic risk, the possibility of losses caused by factors affecting the overall performance of financial markets, such as a major natural disaster, a terrorist attack, an unexpected rise in interest rates, or an economic recession. Markets generally reward investors for taking market risk: the more you take, the greater the potential long-term reward. In practice, though, accepting that risk is far harder than it sounds, because staying invested through turbulent periods tests the resolve of even the calmest investor.

The takeaway: think carefully about your need, your willingness and your ability to take risk, because in many cases you'll have to compromise between them. And don't overlook inflation risk, the extent to which rising prices erode the real value of your investments and your future spending power. Not investing enough is a risk. So is having an investment strategy that's too cautious. In other words, not taking enough risk is itself a risk.

Chapters / Key points

• Why all investing involves a degree of risk
• Why risk and volatility are not the same thing
• What a genuine risk actually looks like
• Concentration risk and having too many eggs in one basket
• Credit risk and the danger of default
• Liquidity risk and why it matters for property investors
• Which risks you can diversify away
• Market risk (systematic risk) and why you can't avoid it
• Why markets reward investors for taking market risk
• Your need, willingness and ability to take risk
• Inflation risk and the danger of being too cautious

Transcript

What are the risks of investing my money?

You can't get away from the fact that all investing involves a degree of risk. The value of your investments can go down as well as up, and you may get less back than you invested. In some cases, you could even lose your entire stake.

Risk is often confused with volatility, but they are in fact two different things. Equities in particular are subject to periods of volatility which can be very extreme. High volatility might keep you awake at night, but it shouldn't be mistaken for risk. An example of a major risk is not having enough money to last your lifespan, or to fund a specific goal.

A common type of investment risk is concentration risk, the risk, if you like, that you have too many eggs in the same basket. There's also credit risk, the danger that a corporation, or even a government, will default on a bond. Then there's liquidity risk, the possibility that you aren't able to realise cash from your investment when you need to. This can be a real concern for those who invest directly in property.

Some risks are more avoidable than others. For example, you can avoid concentration risk by having a diversified portfolio. But one type of risk that you can't diversify away is market risk, also called "systematic risk." Market risk is the possibility that you'll experience losses as a result of factors that affect the overall performance of the financial markets. Examples would be a major natural disaster, a terrorist attack or an unexpected rise in interest rates. Economic recessions can have a very detrimental effect on share prices.

In general, markets reward investors for market risk. The more risk you take, the greater the potential reward you can expect in the long term. In practice, though, accepting market risk is far harder than it sounds. Although they can expect to be compensated with high returns in the long term, those who stay invested when market risks are on the rise will have to endure market fluctuations that can test the resolve of even the calmest investor.

That's why investors have to think very carefully about their need, their willingness and their ability to take risk. In many cases they will need to compromise.

Finally, you should always bear in mind inflation risk. This is the extent to which inflation will erode the real value of your investments and, hence, your future spending power. So, for instance, not investing enough is a risk, and so is having an investment strategy that is too cautious. Yes, that's right, not taking enough risk is itself a risk.