The word risk is thrown around a lot in finance. Generally we hear that if you want higher returns, you will need to take higher risks. A risk by itself is meaningless…. It is simply the likelihood of a certain outcome occurring. This ‘outcome’ is called a hazard. During my time in the construction industry, the concept of a risk matrix was utilised when formulating a plan for any given task. An example of a hazard would have been an outcome such as falling off a ladder. The risk was the chance that someone would fall off the ladder. The risk profile would change depending on the type of ladder you used and preventative measures in place.
Why is any of this important? Well, so you can understand what risk and hazards mean for investing. The hazard for investing is generally one of two things; either losing money or failing to achieve your financial objective i.e. achieving a 2 % stock growth as opposed to 8 %. When financial institutions describe high risk investments for your superannuation this refers to a higher likelihood of your investment being volatile. It could swing high achieving above expected growth as compared to a lower risk profile, but may also swing negative or perform poorly.
So what does risk mean for you and your goals? As a younger investor, I tend toward higher risk investments. I am risk seeking. The reason I take a higher risk stance, is due to my circumstances. I don’t have a family to support nor the responsibilities associated with one. I can afford the losses associated with volatile movements in stocks. If, on the other hand, you were in a position of debt, making monthly repayments on a home and you had a family to support, you might prefer to choose a risk averse profile. While your possibility of significant gains is reduced, the volatility and chance of losing money is mitigated. Some say “Don’t invest what you can’t afford to lose”. I say don’t play risky with what you can’t afford to lose.
One must consider their own position before determining a strategy that is right for them. In my last article I looked into ETFs. As mentioned, there are different kinds of ETFs ranging in risk profile. From a risk averse point of view one might lean toward an ASX200 ETF that has strong diversification among blue chip stocks. A risk seeker may look for a high capital growth tech stocks ETF, targeting high expected growth stocks within the tech sector. As seen by the likes of Amazon and Apple, tech stocks can go gangbusters… but as seen with the dotcom bubble they can easily go bust.
Before investing any money in the stock market is important to analyse your own financial position and determine the risk profile that will suit your circumstances best.
The Informed Investor 