To help you decide which of the options to select, you must first understand some basic essentials of investing. Below are some of the fundamentals that affect investment choices.

Understanding risk and return

Risk can be defined as the possibility of your investment declining in value.  All investments involve some level of risk and the various types of risk are listed in the section on “The risks involved with investing”.

The following diagram illustrates the relationship between the four main asset classes and the levels of risk and return.  As you can see, the higher the potential return on your investment, the higher the potential risk. 

The link between risk and return

The reason we invest in higher risk growth investments is because of the potential for higher returns as the graph above demonstrates. Risk and return tend to be closely related and so by choosing a lower level risk investment or adopting a lower risk investor profile you are also choosing to reduce your longer term returns expectations.

With cash, term deposits and fixed interest investments, there is much greater certainty in the level of returns that can be expected and also much lower likelihood that there would be any erosion of your capital invested. Hence the level of risk is lower than with assets that are more unpredictable such as shares. Growth assets, although much more volatile with no certainty of a capital return in the short term, generally provide the investor with long-term capital growth that is important to counter the effects of inflation and taxation.

We also must consider whether or not we are likely to achieve the goals that we have set ourselves within the time frame that has been established.

When choosing an investment option, you need to think carefully about how much money you will need in retirement and your level of contributions. We encourage you to seek expert advice and start planning for your retirement today.

Volatility

Risk should not be confused with volatility. Volatility refers to the extent to which the value of your investments fluctuate over a period of time. The greater the volatility the more frequent the shifts. Shares, for example, have a higher volatility than fixed interest and cash, with prices changing daily and levels of income distribution changing as well. However, despite short-term unpredictability, the general trend of the volatile price movements in shares over the long term is upwards.

The investment timeframe

Many investors try to predict market cycles and make short-term speculative decisions in order to try and achieve superior returns. History has shown, however that the best way to invest is to consistently buy quality investments and to hold for the long term.

Having sufficient time in the market is an important consideration in selecting investments and strategy. Short-term volatility is less important when we are focused on achieving a long-term growth objective. Risk is dependent on the time frame that we set and generally decreases with time.