There are three major factors every investor must consider before taking any investment decision. The first is the risk-return profile of the investment being courted. Risk is the chance of losing some or all of your invested money due to the price volatility of your investment.
Some investors look out for investment instruments that guarantee safety (near zero risk), and at the same time promise competitive returns. Others are not so bothered about the ‘safety’ of their principal and or the return on investment, if only they are compensated with very high returns.
In the universe of investing, there is an interesting relationship between risk and return, and a clear understanding of this will help an investor make an informed investment decision.
The rule of thumb avers those high-risk investments have a high potential of high returns whereas low risk investments are most likely to yield low returns. The implication is that high levels of uncertainty (high risk) are associated with high potential returns. The risk/return tradeoff is thus the balance between the desire for the lowest possible risk and the highest possible return.
It is worth noting however, that high risk does not necessarily translate into high gains. High risk could potentially pay off with losses depending on the market forces at play at a particular time(T). This is why it is very important to decide what level of risk you can take as an investor in choosing an investment instrument.
WHAT TO DO
To know the level of risk associated with any investment, an investor would thus need to;
i)Consider his/her Investment Objective,
- ii) Know the Investment Duration or Recommended Holding Period (RHP) and
iii)Know the likelihood of that investment achieving the promised potential returns based on its risk/return profile. This will help inform you on the level of risk associated with the investment.
Knowing your risk appetite, you can comfortably now make a decision. Make the effort to learn more about the investment instrument you want to invest in and the potential risk associated with same. Contact a licensed financial advisor today.
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