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The importance of “risk” when making investments

02 December 2015, 09:40Charné van der Walt

The most common question clients ask me when they want to start an investment, whether it is a Retirement Annuity (RA) or Unit Trust account, is “will my investment grow well?”.  

In answering this, we must understand what risk is and how it influences your investment.  

What risk is

Risk is (in my words) the amount of chance you have to take or are willing to take in your investment in order to help your money grow so you have enough for your savings goal like retirement or to buy a house.  Basically, risk is the likelihood of having a loss in the investment while expecting good returns and growth on an investment.

Four things you must know about risk

Firstly, you must know that each person will make a different decision about risk and that there is never a right or wrong approach. When you make an investment, it is a legal requirement that your broker or financial planner must give you a risk profile questionnaire to complete. 

The questionnaire will:

    ask you general questions about the investment you are planning to make;

    determine how much risk you can take (note that the broker can help you with the questionnaire, but only to explain the questions to you,  not to influence your decisions);  and

•    indicate whether your investment must be done as a safer or more risky investment.

Secondly,  make sure you know and understand the basic principles of risk and discuss it with your broker until you are comfortable with the concept of risk.  Here are a few examples of principles that apply to risk :

•    The more risk you are willing to take,  the more the investment can grow, but at the same time,  the more the investment can also lose money.

•    In the same way,  the less risk you are willing to take,  the less the investment can grow but also the less the investment can lose money.

    If you take more risk,  the investment’s value can go up and down more frequently.   Try not to panic when this happens.  Give your investment time to grow through the economy’s ups and downs.

•    If you want your money to grow more,  then you must be willing to take a risk.

•    Risk is necessary to ensure your money grow more than inflation.  Inflation is when your money loses value over time due to price increases.  Your investment must be able to keep up with the increased cost of your lifestyle.

Thirdly,  after completing the questionnaire and making sure you understand the concept of risk,  you will choose a risk category that describes your investment approach to the investment.  Risk categories include the following :

    Conservative or very low risk like cash funds;

    Cautious or low risk;

•    Moderate or medium risk;  and

    Aggressive or high risk (mostly funds with high exposure to shares).

The risk category is important as it helps your broker or financial planners to advise or guide you of what underlying funds (from various insurance companies or asset managers) are suitable for your investment.   

If, for example,  your risk level tests as “aggressive”,  you can take out an investment with an Equity Fund.  If however your risk level tests as Moderate, then a Balanced Fund may be more appropriate.  Or,  you can take a combination of funds to spread the risk even more.  

Fourthly,  the term of your investment will significantly affect the risk you take in your investment.  This means that :

•    longer investment terms helps to “even out” risk;

    you can afford to take more risk when you’re young and when can save for periods of 30 years and longer;

•    you must be committed to an investment and see the term through;  and

•    shorter investments are more sensitive to market changes and need to be done at the right time (enter into market at lower prices and exit at higher prices so you can still enjoy good growth over shorter periods).

It is vital that you understand the investment as well as the risk you are taking.  If you’re not sure,  ask again and again until you are comfortable with your investment choice!

- Woman24


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