Managing the Risks of Investing

There is hardly anything in life that doesn’t involve taking some risk – even getting out of bed in the morning! Many people are fearful of investing because all they focus on is the risk of losing their hard earned money. Others look for great returns and forget about the risk entirely. As with anything, there has to be a balance.

In the majority of investment structures, risk and return are related. The more risk you take, the more return you should be able to potentially make (and vice versa). But are there ways in which this “risk” can be managed without defaulting to low-return products?

Every investment involves the risk you may not get the returns you expected. You can minimise risk by putting money in a bank account. The risk is very low – but so is the return. Taking more risk should bring higher returns but the key is to manage the risks you take. Investment professionals use checklists like this one to focus their minds on minimising risk.

1. No risk means no return

To get ahead, your investment return needs to take account of tax and also stay ahead of inflation. Most low-risk investments will barely achieve that goal. To keep moving forward, you must take some risks. 

2. Seek to understand

Many investment disappointments come from lack of knowledge. You must ask questions until you understand the investment.

3. Consult with experience

Software and mathematical models can help understanding but in the end it is people who make the difference. Smart investors seek the help of experts.

4. Know what you don’t know

It is easy to make assumptions and accept the information as told to you. You must test the assumptions through questioning.

5. Be open

It is easy to pretend that the risks are small. You must accept that risk exists, talk about it fully and manage it.

6. Mix the risks

Diversifying means you take on many uncorrelated risks. The more risks you take, the more consistent the returns.

7. Keep focused

Be consistent. A rigorous and systematic approach will beat a constantly changing strategy every time.

8. Apply common sense

Investing means making judgements rather than following a script. It is better to be approximately right than to be precisely wrong.

9. Return is only half the equation

It is all about risk and return. Accepting and managing the risk will help you achieve the return you desire.

Just like achieving other goals in life, you need to decide how much risk you are prepared to take in chasing higher rewards. This issue is a great one to discuss with your financial planner to see what best suits your situation.

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of the Financial Planning Association
of Australia (FPA)