Understanding the relationship between risk and return
When we talk about risk and return, we are talking about the level of risk that you are willing to take to get a higher return.
All investments carry some risk, and this can never be completely eliminated. However, every investment carries a different level or risk:
Higher risk investment – shares, property, infrastructure and private equity
Generally speaking, higher risk investments earn a higher average return, over the long-term. But, because they have more risk involved, they may also have lower, or even negative returns, in some years. For this reason, higher risk investments are usually better suited to people who have a longer investment timeframe (10 years or more) and can ride out the ups and downs of the market.
Lower risk investments – cash and fixed interest
Lower risk investments on the other hand, usually achieve lower, more consistent returns over the long-term. Because of this, they are usually more suited to people who have a shorter investment timeframe. Investing in them over the long-term could mean that you miss the opportunity to maximise your return and that the growth or your super doesn’t keep up with inflation. Which ultimately may mean that you don’t meet your long-term financial goals.
How much risk are you willing to take?
Everyone has a different tolerance to risk. It’s important to compare the risk and return profile of each of the investment options with your own risk tolerance when deciding on an investment strategy.
The key to choosing your investment strategy is to find the balance between security and performance that you feel most comfortable with and then select the investment option, or options, that you think will best help you achieve your goals.
Your investment timeframe will play a pivotal role when it comes to risk. If your investing for the shorter term (for example, less than five years), it may be more important to minimise the risk of a negative return and choose a lower risk investment strategy, but bear in mind you also risk not keeping up with inflation. If your investing for the longer term (for example, more than five years), a higher-risk investment strategy may be worth considering as there is more time to ride out the ups and downs generally associated with the higher risk investments.
It is also possible that over time your risk tolerance may change. So it is important to review your investment choices from time to time and also talk to one of our planners about your options.