|
One of the central concepts of investment theory is that there is a positive relationship between the level of risk of an investment and its expected level of return - ie the higher the risk the higher the expected return, and vice versa. Although logically most investors would prefer low risk, the risk/return trade off would limit the potential for higher returns. Although some asset classes (particularly shares and property) can demonstrate significant volatility over the short term, history has shown that over the long term these fluctuations can be smoothed out and higher returns can be generated by implementing two main strategies: - diversifying your funds across and within a range of different investments, and
- recognising that different investments have different time frames.
The risk/return trade-off is represented in the following graph:  There are a variety of risks associated with investing, including the following: Mismatch Risk The chosen investment may not be suitable for your needs, goals and circumstances. ^ Inflation Risk Inflation risk the real purchasing power of your invested funds may not keep pace with inflation. ^ Reinvestment Risk If you rely on fixed rate investments you may have to reinvest maturing money at a lower rate of interest. ^ Market Risk Movements in the market mean the value of your investment can go down as well as up - and sometimes suddenly. ^ Timing Risk Trying to time entry to and exit from markets can expose you to potentially greater short-term volatility. ^ Risk of not Diversifying If you put all of your capital into one market a fall in that market will adversely affect all of your capital. ^ Liquidity Risk You may not be able to access your money as quickly as you need to without suffering a fall in value. ^ Credit Risk The institution you have invested with may not be able to make the required interest payments or repay your funds. ^ Legislative Risk Your investment strategies or products could be affected by changes in current laws and regulations. ^ Value Risk You may pay too much for the investment or sell it too cheaply. ^ Manager Risk The personnel or ownership of the fund manager may change so that the manager no longer has access to the skills or attitudes that contributed to earlier performance levels. ^ Currency Risk Investments in assets located in other countries may rise or fall in value due to the relative value of the Australian currency. ^
|
