Investment Risks
Determine your attitude to risk
Before investing, it's important to evaluate your risk profile, that is, the extent to which you are prepared to accept the risk of low or negative returns in any given year for the possibility of higher gains over the long term.
It is human nature to want the highest level of return with the lowest possible risk - but it is very rare to have both. Investing always involves a trade-off between risk and return.
Types of investment risk
Investments carry varying degrees of risk and the value of investments can fall as well as rise. Many factors affect the value and possible investment returns of these assets. Generally, the higher the potential returns, the higher the risks. Some of the main risks of investing in the investment options include:
Type of risk |
Managing the risk |
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Market risk |
This is the risk that affects specific markets. Factors such as investor sentiment, economic impacts, regulatory conditions and political events will determine market performance. |
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Investment risk |
Regardless of the type of interest option you choose, the value of your investment can fall and you may get back less than you invested. Even if the investment does not fall in value, it may not perform according to your expectations, or the investment managers may not be able to achieve their stated aims and objectives. |
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Inflation risk |
While your investment may produce a positive return, when it is compared to the increase in the cost of living, you may have reduced purchasing power. |
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Company and credit risk |
Investments such as shares provides exposure to a company and its business environment, factors that are outside the market's control. Changes to a company's management, legal action against the company and its profit and loss announcements, for example, can have a positive or negative effect on market perceptions and in turn, affect investment return. |
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Currency risk |
Investments in international markets usually involve currency risk. Currency risk is the potential for adverse movements in exchange rates to reduce the Australian dollar value of international investments. Currency risk applies to all investment options that have international assets exposure. |
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Interest rate risk |
This refers to changes in the market values of securities, especially fixed interest securities. An increase in market interest rates usually produces a reduction in the market value of fixed interest securities. Similarly, a reduction in market interest rates usually produces an increase in the market value of fixed interest securities. |
Look long term to reduce investment risk
One of the most effective ways to reduce risk is to invest over the long term. For example, over a long term period (seven years or more) the volatility associated with riskier asset classes such as shares is substantially reduced.
Compare the results of different assets over time
The graph below shows the returns of five different asset types from 1979 to 2004, a period of 25 years. It is important to note that the returns shown in the chart are historical. Investment returns are volatile and past performance is not a reliable indicator of future performance.
Click here to display the 'growth assets' graph
The graph shows that 'growth assets' like shares generally delivered a higher return over time than low risk investments such as cash.
