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Understanding risk and return

There are different levels of risk attached to different types of investments. We give you a basic overview of risk and return, and how this applies to the different asset classes.

Investing is different to simply saving money, as both your potential returns and losses are greater.


Within the world of investing itself, there are also different levels of risk attached to different types of investments.


As a general rule, the more money you stand to make, the more money you stand to lose because you typically need to take on more risk to achieve higher returns.


Talking to someone about your ability to cope with financial stress can help you decide how you feel about taking on investment risk, even if it’s just a member of your family or a friend whose opinion you respect.


A professional financial planner should also be able to help guide you through some different options and outline the different levels of risk involved.


When do you need your money?


If you’re retiring in the next one to two years, for example, it probably isn’t the right time to put all of your savings into a high risk investment.


You may be better off choosing something like a cash account or some bonds that will protect the bulk of your money, while putting just a small sum into a more growth-focused option such as shares.


Or, you may be a few months away from putting down a deposit on your first home loan. In this case, you would probably also choose a more conservative investment that keeps your savings safe in the short-term.


On the other hand, if you have just recently started working and saving, you may be happy to invest a larger chunk of your money into a higher risk/higher potential returns investment, knowing you won’t need it in the immediate future.


How do I choose an investment option?


Different investments perform differently over time.


Investments that have provided higher returns over the longer term have also tended to produce a wider range of returns.


These investments are generally described as more risky, as there is a higher chance of losing money, but they can also give you a better chance of achieving your long-term objectives.


Investments that have provided more stable returns are considered less risky, but they may not provide sufficient long-term returns for you to achieve your long-term goals.


Selecting the investments that best match your investment needs and timeframe is crucial in managing this risk.


Cash, fixed interest, shares or property?


A little knowledge can go a long way when deciding which investment may suit your tolerance to risk, investment goals, circumstances and timeframe. That’s why it is important to have some idea of where your money is going and how your ‘investment mix' or asset allocation is made up.


The most common asset classes represent different types of investment – cash, fixed interest, shares and property. Each asset class has a different level of risk and return, which means they can perform differently over time.


Let’s look at the risk measure categories combined with the different types of asset classes.


What is the Standard Risk Measure?


The Standard Risk Measure (SRM) allows investors to compare investment options that are expected to deliver a similar number of negative annual returns over any 20-year period (as outlined in the risk measure category table below).


The SRM for each option is also a measure of the risk objective of the option and the expected variability of the return of the option.


The SRM is not a complete assessment of all forms of investment risk. For instance, it doesn’t detail what the size of a negative return could be or the potential for a positive return to be less than what you may require to meet your objectives.


Further, it doesn’t take into account the impact of administration fees and tax on the likelihood of a negative return. So it’s important to ensure you’re comfortable with the risks and potential losses associated with your chosen investment option(s).


The SRM should not be considered personal advice and you should regularly review your investment decisions with your financial adviser.
 

Risk measure categories

Below is a table that outlines our labelling of risk measures and categories.

Risk measure categories

How do these risk measures apply to asset classes?

How do these risk measures apply to asset classes?

Different options have different risk/potential return characteristics as shown in the graph below.

Risk and potential return

A financial adviser can help you understand investment risks, including those applicable to complex options, and design an investment strategy that is right for you.

Disclaimer
Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) is the issuer of super, pension and investment products. This document may include general advice but does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision. A PDS for Colonial First State’s products are available at colonialfirststate.com.au or by calling us on 13 13 36.