The key to investment is finding the right balance between risk and return. There is no such thing as a safe investment, despite what some financial advisers might have you believe. Risk is inherent and can be managed, but certainly not removed entirely. Investment planning is crucial in finding the right way to balance this risk and develop a portfolio that is aligned with your current circumstances and long-term aspirations. Fundamental in this diversification is selecting assets that behave in different ways.
Investment ‘styles’
Some forms of investment can behave in a contrary way, so much so that they can be said to be in negative correlation with one another. For example, while property and bonds provide a stable investment with low returns, equities (stocks and shares) offer the potential for higher returns but with an increased level of risk.
By diversifying and creating a portfolio with the right blend of asset classes to reflect your approach to risk and return, it is possible to create a ‘safety net’ and ensure there is not an overreliance on a particular asset.
It is also possible to diversify in other ways, such as the size of the company you invest in, their geographic location, and the sector they operate in. There are also different approaches to investment, namely growth and value investing. Growth equities are those where the value will increase over the longer term, whilst value equities represent a different type of investment as they are being offered at less than the company’s intrinsic worth. With conscientious investment planning, it is possible to reduce the overall risk rating of your investment portfolio.
A paper loss
With risk inherent in every investment, there are times when your investment will fall in value. This is known as a paper loss, as it will not represent an actual loss unless you choose to cash in on the investment at that time. If you are going to invest, the intrinsic risk involved means that at some point, you will experience a paper loss on the value of your investment. However, the less risk your investment portfolio is exposed to, the more gradual your returns, so, although you may not experience a paper loss, your returns will also be tempered.
Currency risk
If you are investing in asset classes in another country, you will be exposed to a risk over and above that a domestic investment would ordinarily face. When investing abroad, you also have to factor in the effect of the fluctuati
on of currencies on your investment, as well as normal share price movements.
Another currency consideration that should be taken into account is the impact inflation will have on your investment. Inflation is the process by which the purchasing value of money falls in line with a general increase in prices. If the return on your investment is not greater than the current level of inflation, the value of your investment will actually fall. Cash investment is one of the safest investments you can make, but only if the returns exceed the value of inflation over the longer term.
To conclude…
Past performance offers no protection against the future. The market value of investments and currencies is constantly fluctuating, which means the income you can expect as a return on your investment can fall just as easily as it can rise. Diversification is essential in managing this risk, but there is still no guarantee that you will receive more than your initial investment.
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