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Time and again, investors after having lost their hard-earned savings in investments
only start to wish they had asked the few important questions concerning risk. Most
do not understand the relationship between risk and return and ways of managing risk.
Very often investors jump into an investment upon seeing the potential rewards without
studying the level of risk involved. Many are afraid of taking losses and yet avoid
talking about risks.
Broadly, the term "risk" in the investment world simply means the probability
of having your entire investment capital due to price fluctuations in the market
affected by various variables such as political and economic factors. When investors
think of the word "risk", they normally think of short-term losses.
Recently, Normandy had a caller who commented that "amid the current market
turmoil, wouldn't it be great to find a place elsewhere to put your money where it
would grow comfortably without any element of risk?".
The fact is any form of investing involves some degree of risk be it fixed deposits
or commodities. Generally speaking, conservative people invest in a relatively safe
way (but not zero risk) even though they know that they may actually earn less on
their investments. Others are willing to accept a higher level of risk in the return
for the possibility of a higher return.
All things being equal, when choosing between two investments with the same returns
but in different risk categories, investors would definitely choose the one with
the lesser risk.
Take for example, two types of investments, A and B. Option A secures you a guaranteed
return of 12% over a period of say 6 months. Option B on the other hand, promises
a similar return over the same period but the value of the investment fluctuates
at the mercy of the markets.
Certainly, you would prefer the risk-free option A. You would avoid option B as there
is a chance that the value of the investment could fall to a low at the time you
need to liquidate the investment.
Different investments will have different risk/return characteristics. History has
shown that riskier investments such as stocks tend to perform better over the long-term
than conservative investments such as fixed deposits or bonds. Investing in a unit
trust may give a slightly lower yield but the risk is much lower than investing directly
in the stockmarket.
That's right, higher returns always come with higher risks - a standard equation
that everyone should keep in mind each time they have to make an investment decision
or pick an investment option.
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