During periods of low investment growth, investors often re-examine their appetite for risk in search of better returns and higher yielding investments. This strategy may be successful, but organisations need to ensure that they understand, and are able to tolerate the risks.
What is investment risk?
There are many types of investment risk. When it comes to investment returns, risk is the variability (or volatility) of your investment and the chance that your investment won’t return the outcomes you want. If you think of your investment strategy as a journey, you may start with investments such as cash, which have lower risks and generate low returns. As your desire for returns and risk appetite grows you may look at other types of investments such as property and Australian equities. One approach to managing the risk associated with these types of investments is by diversifying or mixing the asset combinations.
What is return?
To determine how profitable an investment is, investors look at how much they stand to profit from investing in a particular stock. Relative to the cost of your investment, it is usually expressed as a percentage, so a $100 return on a $1000 investment in a stock is a 10% return. Not all investments have high returns, so investors then compare the percentages of different investments and take into account their exposure to market risks, to determine what is most profitable.
Aligning risk perceptions with reality
This prolonged period of low growth and low interest rates is uncharted territory for investments and risk. Before the Global Financial Crisis (GFC), high interest rates meant higher returns on lower risk investments, like cash (see graph 1.0). Therefore, investors were not under pressure to engage in riskier investments, like property or Australian equities, to get returns. Where the market has lower interest rate expectations, such as in today’s economic environment, investors often re-examine their appetite for risk and move up the risk spectrum in search of higher yielding investments and better returns.
Risk and you
The key here is to consider your appetite for risk and your investment time horizon. While interest rates remain low, for those investors relying on investments as an income stream from cash or fixed interest, as is the case with many Church entities, the risk is these investments may not provide sufficient long-term returns to achieve an organisation’s objectives. In some cases, it means lower than expected returns and potentially not achieving a return above the rate of inflation.
What can I do?
The best way to rest easy at night is:
1. Understand your risk tolerance.
2. Understand your investable time horizon.
3. Diversify your investment across different asset classes, so you spread risk.
This way, you can align an appropriate investment strategy to your risk and return preferences.
Taking risks can have great rewards – it’s all about being comfortable with, and understanding, those risks.
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