Risk versus reward
Find out more about investment basics:
Risk versus reward
There is a rule of thumb in investing – the higher the risk, the greater the potential for reward.
When you invest there is a risk that the value of your investment will fall – or will not increase at the expected rate. There is a rule of thumb in investing – the higher the risk, the greater the potential for reward. Generally, when you lower your risk, you lower your potential for reward. Your investment simply may not grow enough to stay ahead of inflation. For example, if inflation averages say 3%, your investment needs to grow by more than 3% to increase its real value.
Reward is the rate at which your investment increases. In other words, reward is the return on your investment. Some investors are more comfortable with the “rollercoaster ride” of high-risk investments than others. Even if you have low risk tolerance, you may wish to include some higher-risk investments in your portfolio as part of a long-term investment strategy because of the potential for higher returns.
Every investor faces the classic trade-off of risk versus reward. You must balance your tolerance for risk against the rate of return you wish to obtain. This balance forms the foundation of your investment strategy. An aggressive investment strategy is more likely to include businesses (a software company, for instance) that could produce huge profits in a good year, but lower dividends and falling share values in a bad one. A conservative investment strategy, is more likely to include investments such as government bonds, promising a fixed rate of return (albeit not very high) with little chance of losing the initial money invested. A moderate investment strategy typically includes a combination of bonds and investments in the stocks of medium to large-sized well established companies.
An aggressive investment strategy is often more appropriate for someone who is many years away from retirement. If you have only a few years to go to retirement, you probably will not want to take much risk with your pension account, so a more conservative investment strategy might suit you better. If you are in the middle of your working years, a moderate investment strategy may be the best choice, because your retirement is far enough away that you can ride out any “ups and downs” in the market.