When you own a house, for example, there’s always a risk that the property market could fall and reduce the value of your home at that point in time. Or, in the case of an investment property, there’s a risk that your tenant could move out and leave you with no rental income to cover your monthly mortgage payments and other costs.
As many of us experienced last year, unforeseen events also can lead to very sudden and sharp falls on share markets. Investors who panicked and sold out when markets fell in early 2020 not only suffered heavy losses, but they probably missed out totally on the strong rebound of financial markets over the remainder of the year. And then there’s the risk at the moment of leaving lots of your money in a savings account. Record-low interest rates mean cash is currently earning little or no return at all. After account fees and the eroding effects of inflation on the purchasing power of money, cash held in savings is effectively going backwards.
Related article: 4 Financial risks that investors should be aware of
Risk-taking is on the rise
It’s likely that the impact of record-low interest rates is currently behind a noticeable trend. In short, there seems to be a big increase in risky investment behaviour right around the world. At least, that’s one way of describing it. Perhaps, more accurately, some of the activity going on sits somewhere between high-risk speculation and outright gambling.
On the United States share market, for example, there’s been a wave of speculative buying into certain companies largely based on conversations published on online investment chat forums and social media channels. Groups of speculators, eager to make quick profits, have been behind heavy buying into these targeted companies. As share prices have skyrocketed, that’s been followed by very heavy selling. While some speculators have made big gains, others that rushed in blindly have made big losses by being caught out when a share price has dropped back suddenly.
There also has been a renewed rush into cryptocurrencies in recent weeks — once again this may be largely driven by speculators wanting to make quick gains.
Related article: Shorting stocks: How does short selling a stock work?
If you’re comparing online share trading companies, the comparison table below displays some of the companies available on Canstar’s database with links to providers’ websites. The information displayed is based on an average of six trades per month. Please note the table is sorted by Star Rating (highest to lowest), followed by provider name (alphabetical). Use Canstar’s Online Share Trading comparison selector to view a wider range of online share trading companies.
A rush into bonds
Record-low interest rates seem to also be behind a flood of investing into what are known as high-yield corporate bonds. They pay higher income returns than other types of bond securities. The reason for that is because the some of the companies issuing high-yield bonds have weak credit ratings, and have a higher risk of defaulting on their repayments to lenders including bond investors. Borrowing money has never been cheaper than now, but companies under financial stress may have trouble getting finance through banks and other lenders.
An alternative is to issue new bonds to investors that pay out a higher interest rate return than can be received on bonds issued by governments and companies with higher credit ratings. But the very strong demand for high-yield bonds recently has pushed up their market prices, and this has resulted in their investment yields falling to the lowest levels ever seen. That’s because bond yields typically fall when market prices rise, and vice versa. Prices and yields generally move in opposite directions to each other. So, for taking a higher risk by buying into bonds with low credit ratings, some investors are now getting lower yield returns than they’d bargained for.
What can you do to manage the risk versus reward conundrum
In basic terms, the higher the potential reward, the higher the risk of losing money. The lower the risk, the lower the potential reward.
Diversification within your investment portfolio
Diversification within asset classes, and across different asset classes, is often considered to be a useful strategy for managing traditional risks.
Long term approach to investing
It’s also important to have a long-term approach to investing, because most risks are shorter-term in nature. Investment risks come in many forms. As well as general market risks, there are security specific risks, where a particular company can be impacted by events, down to things such as economic risks, geopolitical risks (risks associated with countries and regions), and liquidity risk where you may not be able to convert your investment back into cash at short notice. Then there can be operational risks, where an unexpected event such as a natural disaster, a war or civil disturbance, or even a technology failure, can affect the operation of a stock exchange. But by having a long term approach to investing, often you can weather the storm and your investments will likely smooth over time.
Related article: How Australian Shares have performed in the last 30 years
Risk appetite and investment goals
If you ask a financial adviser where you can invest your money, one of the first things they should ask you is how much risk are you comfortable in taking. Assessing your risk appetite, your overall investment goals and your time frame, will help to determine the types of assets you may want to invest in.
That’s why understanding different types of risks, and why some assets are lower or higher risk than others, is such an important part of your investment planning process.
Main image source: William Potter (Shutterstock.com)
About Tony Kaye
Tony Kaye is Senior Personal Finance Writer at Vanguard. He was a former manager at Standard & Poor’s Ratings and has a regular column in the Australian’s Wealth section. Tony has also written for newspapers nationally; The Telegraph, The Herald-Sun, The Advertiser, The Courier-Mail, NT News, Canberra Times and more. He has a Bachelor of Arts and Journalism at Curtin University and Public Relations at RMIT University.
Follow him on LinkedIn.