Risk vs return - what is the perfect investment?
- Financial Planning
Of course, we’d all love to find the perfect investment which has low risk and high returns. However, is it even possible? We break down the basics and investigate.
So, what is the relationship between risk and return? Unfortunately, while the lure of finding a low risk investment with a high return is inviting it doesn’t exist because risk and return are positively related. This means that the lower risk investments – while excellent for peace of mind – will generally provide a lower long-term return than a high risk investment.
The chart below shows the risk return profiles of each of the different asset classes: international shares, Australian shares, high yield and hybrid securities, fixed interest, cash, property, higher return, lower return, lower risk, higher risk
How do I manage investment risk?
- Diversification means spreading your investments across a variety of asset classes. In doing so, the positive returns you receive from one investment can generally offset any negative returns you may receive from other investments.
- Your investment time frame also has a significant impact on your investment decisions and, therefore, the amount of risk you take. Usually, your age and relative proximity to retirement will determine whether you’re investing for the short, medium or long term.
- Review your plan regularly as once developed, your investment strategy should consider all aspects of your personal situation. If your circumstances change, therefore, it’s important that your plan is updated accordingly.
What is the key to diversification?
When choosing your asset allocation, it is essential that you spread your investments across different asset classes and investment products, so that all of your financial eggs are not in the one basket. Diversification is key to boosting your investment returns; the possibility of higher returns from growth assets together with the stability of lower risk defensive assets. The main benefit is that if one or two of the assets are performing poorly you have other assets that may be performing better and which could possibly balance out your losses. It’s also important that your investment portfolio is diversified within, as well as, across all asset classes.
What is a realistic investment time frame?
How long you have to invest, or your investment time frame, is a great starting point for determining your investment strategy. Usually, your age and relative proximity to retirement will help you determine your goals and therefore, whether you’re investing for the short term (one to three years) medium term (three to five years), or long term (more than five years).
Over time, investment markets fluctuate up and down as does the value of your investments. If you have many years over which to invest, you may be prepared to take on more risk. In this situation, with more time to ride out any short-term fluctuations in investment returns, you have the opportunity to benefit from the higher expected returns offered by growth investments such as shares.
If, on the other hand, you only have a couple of years over which to invest, you’re generally investing for the short term and security may be more important than higher returns. Accordingly, you might put a greater emphasis on placing your investments in short-term, more secure assets, such as cash and fixed interest. So, how do I begin to plan ahead? Once developed, your investment strategy should incorporate all aspects of your personal finances. It’s therefore important to keep to your strategy to give yourself the greatest chance of achieving your financial goals. After all, your investment strategy has been designed to assist you over the short, medium and long-term and the success of the strategy depends on whether you adhere to it.
Are you retirement ready financially? More than one in three Australians aged between 45 and 65 years old believe that they will be unlikely to reach the level of wealth required to maintain their lifestyle in retirement. Join our conversation below