Back to: Understanding investing

All investing involves a trade-off between risk and return. Risk goes with the investment territory. So rather than avoid risk, it makes better sense to understand it.

Investment risk is the risk that you might have to sell at a time when the investment is worth less than you paid for it. So the more volatile an investment is the greater the fluctuation in return from month to month or year to year.

Tips on understanding and managing risk:

Generally the higher the return the higher the risk The higher the potential return, the higher the potential loss Negative returns are possible for most investment types Understand the risks involved Be comfortable with the level of risk Don't take unnecessary risk

The chart below tracks the returns of the main asset classes. As you can see, international shares have been the most volatile, so there were many occasions when they could have been worth less than you paid for them. On the other hand, if you had been a long–term investor in international shares from June 1986 to June 2006, $1,000 invested would now be worth over $11,000.

At the other extreme is cash. No nasty downturns, but $1,000 invested in 1986 would now be worth only $6,000.

The most important element of the risk/return equation is you. Your attitude to risk should be the main driver of your investment decisions. You need investments that will allow you to sleep soundly at night but work hard towards achieving your financial goals.

Source: MSCI World ex Australia index-Net Dividends Reinvested in AUD, S&P/ASX 300 Property Trusts Accum Index, S&P/ASX 300 ex LPT Accum Index, UBS Composite Bond Index (all Maturities), UBS Bank Bill Index. Assumes reinvestment of income and does not take into account taxation, inflation, fees or expenses. Past performance is not a reliable indicator of future performance.