Saving and investing are important parts of your financial plan. What you save and invest should help you reach your financial goals. However, all investments come with risk. Investments offering potentially higher expected returns also expose you to a higher risk of losing money. This is known as the risk-return trade-off.
What is a return?
The return on an investment is the gain or loss made on the investment. It can be income earned from a product and / or the capital gain or loss (price gain or loss) on the product.
Examples of income include interest you earn from a bank deposit, or the coupon you receive from a bond, or the dividend payment from shares or unit trusts you hold. At times, in order to meet its income payout objective, managers may even facilitate a payment out of a fund’s capital.
Capital gain or loss
This is the gain or loss you make if you sell an asset at a higher or lower price than the price you originally paid when you bought it.
Remember to deduct any transaction costs when working out your net returns. There could be sales charges, management fees and brokerage charges depending on the types of products you buy. There could also be financing or borrowing costs if you buy a product using margin or leverage.
What is risk?
The actual return from an investment may be more or less than what you expected at the time you bought the product – this is the risk you take when investing.
Investment risk can refer to:
- Lower than expected returns, for example, due to share price volatility or the underperformance of a fund
- The possibility of losing money invested, e.g. when a bond issuer defaults on interest or principal payments. In some cases, you may lose all of the money you invested.
All investments come with the risk of losing money, whether it’s the amount you invested or a loss in earnings.
Types of risks
There are risks that affect investments generally, for example, overall economic conditions, political stability, changes in interest rates or the availability of credit, all of which can affect market and general business conditions.
There are also risks which may apply more specifically to a particular investment. For example, if a company loses dominance in a key market, is hit by a scandal over defective products or there are concerns about its poor management, its share price may plunge. You can reduce these risks if you spread your money over different investments, e.g. different products like bonds and shares and different economic sectors or regions. Do read the product documentation to understand the different risks, especially for complex products like structured notes or products which are bought using leverage.
Investments that offer the potential for higher expected returns come with higher risk of loss for the investor. This is called the risk-return tradeoff. When you invest in a product offering higher potential returns, the tradeoff is that you are exposed to a higher risk of losing some or all of the money invested. If you are uncomfortable with the risk of losing money, you must be prepared to invest in less risky products which will earn lower returns.
Before you invest your money, ask yourself how much you can lose in the worst case scenario and whether you can afford this.