When we invest money, we would all like the same thing: good returns with as little risk as possible. Unfortunately, investing doesn’t quite work that way. Generally, the opportunity for higher returns comes with greater uncertainty and greater movement in the value of our investments.
Importantly, risk doesn’t simply mean losing money. It can also mean volatility — the normal movement of investment values up and down over time.
Where is your money invested?
Most investment portfolios contain different asset classes, each carrying different levels of risk.
Cash and money-market investments generally have low volatility and provide stability, but their returns may struggle to beat inflation over longer periods.
Bonds and fixed-interest investments involve lending money to governments or companies in return for interest. They tend to be less volatile than shares, although their values can still be affected by interest rates, inflation and economic conditions.
Property investments provide exposure to assets such as offices, shopping centres and warehouses. Returns come from rental income and changes in property values, but property can suffer when interest rates rise or economic conditions weaken.
Then we have equities or shares. When you buy shares, you effectively own a small part of a business. You participate in its growth and profits — but also in its difficulties.
Share prices can be influenced by company profits, interest rates, inflation, politics, exchange rates, commodity prices and investor sentiment. This explains why equity markets can sometimes move dramatically over short periods.
Time changes the risk
This is where your investment period becomes extremely important.
If you need your money next year, a sudden fall in the share market could create a serious problem because you may have to sell at the wrong time. But if you’re investing for retirement 15 or 20 years from now, short-term market movements have a very different significance.
A temporary fall in value is therefore not necessarily a permanent loss. Time can provide an investment with an opportunity to recover.
The important conversation
The question shouldn’t simply be: “What return would I like?”
A better question is: “What return do I need, how much risk can I reasonably accept, and how much time do I have?”
Successful investing is not about avoiding every market decline. It is about accepting an appropriate level of risk, diversifying your investments and, most importantly, giving your money enough time to do its job.