Are you the adventurous type, drawn to the thrill of the unknown—perhaps even a bit of a daredevil? If you are, chances are you’re also a bit of a risk-taker when it comes to your finances. But is this a good thing? Let’s delve deeper.

Understanding the Risk-Return Spectrum

The perfect investment—high returns, zero risk, and immediate access to your capital—is a mirage. If such an investment existed, we wouldn’t need to engage with stocks, bonds, properties, or commodities. The cold, hard truth is that risk and return share an inverse relationship.

“If high returns are what you’re after, then you must be prepared to accept the possibility of losing some, if not all, of your investment. If you prefer not to gamble with your money, then leaving it in a bank account with a modest return is your best bet.”

However, risk is a multi-layered concept.

The multi-dimensionality of risk

While the risk-return relationship holds true, it’s not as straightforward as it may seem. Time is a significant factor to consider. For instance, buying shares with the intention of quick turnover could potentially result in a loss. But if you’re investing in a stable ‘blue-chip’ company with a long-term perspective, the risk is considerably lower.

“Over time, quality shares are likely to appreciate and provide substantial dividends. To minimise risk, it’s advisable to diversify your portfolio, as even blue-chip companies can hit hard times, as happened with BP after the catastrophic oil spill in the Gulf of Mexico.”

Another crucial aspect is liquidity—the ability to quickly convert an asset into cash. A lack of liquidity can pose a risk, as running out of cash can lead to insolvency.

Categorising Assets Based on Risk

Several factors influence the risk level of an asset. Here’s a general guide:

1. No Risk: Sadly, no asset falls into this category. Even banks and government guarantees have vulnerabilities.
2. Very Low Risk: Multiple deposits in different currencies in government, large private, or international banks. However, bear in mind that holding cash long-term can erode its purchasing power due to inflation.
3. Low Risk: One or two deposits, as described above.
4. Fairly Low Risk: Government bonds are relatively safe as governments can print money to meet their obligations. However, the value of bonds and currencies can fluctuate.
5. Low to Medium Risk: Corporate bonds, if diversified, could default as a single company. Major market equities for the long term and land and property are other examples.
6. High Risk: Emerging market equities, commodities, futures, and private equity.
7. Very High Risk: Complex investment vehicles like derivatives. These are best left to the pros.
8. Variable Risk: Some assets, like hedge funds, can range from low to high risk.

The final word

If you cannot afford to lose any portion of your capital, it is advisable to stick to the lower end of the risk spectrum. However, for those with a healthy cash reserve looking to build wealth, some degree of risk-taking is necessary.

“Taking financial risks, when managed well, can lead to substantial returns. This typically involves diversifying your portfolio across various risk levels and committing to medium-to-long-term investments. Yes, there will be losses, but as the saying goes, there is no gain without pain.”

After all, a life without risk can indeed be quite dull. So go on, take that leap of faith—in finance and in life!

Learn more about financial risk-taking during a free, no-obligation consultation.