Ask anyone what they think about investing and the word ‘risk’ is likely to come up. In a survey we conducted, one in four people said they’re put off investing because they think it’s too risky for them.
But what does too risky mean? Like many things, the level of risk you expose yourself to depends on your choices. You can decide to play tennis or go skydiving, but the latter is likely to give you a greater sense of achievement, if you’re willing to take the risk.
Similarly, the choices investors make involve varying levels of risk and reward. One way to help reduce your risk is to not put all your eggs in one basket.
In this analogy, the basket is an investment, like a stock or bond and the eggs are your money. If you put all your eggs into the same basket, and that basket fails (i.e. the share price suddenly tumbles), you may lose some eggs.
Understanding the different types of baskets
You could stick to relatively ‘safe’ baskets, like cash equivalents and bonds, but these less volatile baskets will also typically give you lower returns.
Meanwhile, higher-risk baskets like stocks, private equity or hedge funds can potentially give you much better chance of bigger returns but come with the potential for bigger losses.
There’s also the question of which market to choose. Markets in Japan and Asia tend to carry a higher risk than areas like the UK but can also give you bigger returns, or bigger losses.
Taking a balanced approach
A balanced approach could be to choose a combination of risky and less risky investments for your portfolio (collection of investments). The lower risk investments help balance out the potential instability of the riskier ones, spreading risk more evenly across your portfolio and making you less dependent on the success of one or two investments.
As a rule, the more varied your overall portfolio, the more balanced it is.
In the investing world, this is rather grandly known as ‘diversification’, but put simply, it’s the best way you can try to keep your eggs safe!
With investing your capital is at risk and you may get back less than you put in.