Risk

Nothing comes for free and neither does the return on your investment. The price one pays for potentially higher returns from any instrument is based on the risk that the instrument carries.

There is always a chance that an investment's actual return is higher or lower than what you expect it to provide. It may so happen that your investment in any instrument may yield returns higher than your expectation. On the flip side, you may end up losing a part or all of your original investment (principal). This is called 'Risk'. Hence, the fluctuation that the value of your investment goes through results in risk. To judge the 'effect' of risk on your investment, you need to look at its tendency to fall or rise over a period of time. It is but natural of anyone to worry about the risks involved in any investment and the possible loss of ones hard earned money. However, you need to understand that every instrument (including your money in the savings bank) carry a certain amount of risk. Therefore, it is imperative to deal with risk correctly rather than try to avoid it completely.

We just saw in Investment Objective that in most cases the implied return is more than what savings can provide. This is when you invest to aim for higher returns. Investment vehicles that provide higher returns do have a higher element of risk, but these risks can be weathered over a sufficient period of time. The highs and lows get averaged out in long run. Those who have the luxury of time can invest in equity based funds which may be prone to more fluctuations on the short run, but have been known to give amazing returns over longer periods of time. For those who are interested in short term investments or have a more urgent need, investing in debt based funds would be more suitable, as they provide more stable income, moderate growth and the risks associated with it are considerably lower.

An investor's risk profile has a lot to do with the way his investments are allocated. An investor in his twenties making provisions for retirement can be more aggressive with his investments, whereas one in his forties, who also needs to look after his children's needs, will approach it differently. An aggressive growth portfolio allocates around 60% in stocks or equities; a moderate growth portfolio suggests around 40% each in equities and debt based funds, whereas a typical conservative growth portfolio would have only around 15% in stocks. An aggressive growth portfolio would be the best bet for an individual who has the time and cash to spare and is open to risks, in the hope for a major payoff later. Those who are relying on a certain amount of regular income are better suited to a more conservative portfolio.

Essentially your appetite for risk depends on your personality and personal circumstances. Nowadays investors have a varied choice among the different asset classes and can create a portfolio that they are comfortable with. Therefore, the intelligent choice is to manage or control your risk and not shy away from it completely.