For first-time investors, hearing the words ‘my money’ and ‘risk’ in the same sentence can be a little scary. You worked hard for that cash and you don’t want to feel like you’re gambling with it. But risk, in investment terms, comes in manageable levels. It’s a choose-your-own-adventure situation, and settling on the right amount of risk for you can be very good for your portfolio.
What is risk?
Risk is the chance that your investment’s return will be different to what you expected it to be. Let’s be real: when we say “different to”, we mean “less than”. Nobody’s particularly worried about an event in which their investment outperforms their wildest expectations.
Let’s say you put R1 000 into an asset in January, hoping it turns into R1 250 by the time you sell it in December of that year. Your investment may do exactly that, but there’s also the risk that your R1 000 becomes R900, or R500 – or R0. *Gulp*
Why take on any risk at all?
Think of risk as the price you pay for access to the stock market’s potentially big returns. No risk, no reward. The alternative is to put your money into a virtually risk-free savings account at your bank. Of course, if you do that, its growth won’t outperform inflation. Further down the line, your nest egg will be worth less than it was when you first tucked it away into that account. The numbers might be bigger but it won’t keep up its buying power.
Investing is a crucial part of personal finance, then. And risk is an unavoidable part of investing. But let’s be very clear here: investing is not the same as gambling. You get to decide how much risk you engage in, and you can take steps to mitigate it overall.
What’s your risk profile?
You may hear people talking about risk in terms of your appetite for it, also known as your individual risk profile. This is your willingness and ability to take investment risks. How do you know what your risk profile is? It’s typically based on factors such as your age, lifestyle, your assets (things you have) versus your liabilities (things you owe), and even your personality.
For example, a 64-year-old planning to retire next year and cash out his savings may be more risk averse than a 25-year-old who has four decades ahead of them in which to ride out market volatility. The longer the period of your investment, the more risk you can usually afford to take on (more on this below).
But it’s not just about time. Let’s look at two 30-year-olds. Zainab has been contributing to her retirement savings every month since she started working at 21. She has an emergency fund of six months’ living expenses and has no debt. Phillip, on the other hand, has been sleeping on saving for retirement, has maxed out his credit card and various store accounts, and he doesn’t insure his car, which he needs in order to earn money as a wedding photographer. Zainab has a far greater ability to take on risk than Phillip does. She can afford to go after big returns a little more aggressively because she won’t tank her entire financial future if that one investment goes south. Phillip would be advised to play it safe until he’s more financially stable.
Personality also comes into play here. Zainab may not enjoy risk at all, and is therefore happy to forego potential big returns and instead stick with low-risk investments. That’s her prerogative. Phillip, despite a low ability for risk, may be willing to bet the farm on what he considers to be the next big thing (although a good financial advisor would strongly urge him not to).
A few things that impact risk
- Diversification
The more diverse your portfolio, the more you reduce your risk overall (you can brush up on diversification over here). For example, it’s considered less risky to invest in a nice, balanced ETF than in an individual company. An example of a risky investment might be a US tech company’s IPO. Maybe you’ll be in on the next Apple (AAPL). Then again, maybe not, so you probably don’t want this one investment to constitute 100% of your portfolio. - Volatility
Think of a graph showing a share’s performance. Even if the price is trending upwards over time, there are lots of squiggly ups and downs along the way. That’s volatility. It’s not necessarily a bad thing. A little turbulence when you’re flying from Cape Town to Jozi doesn’t mean the plane isn’t going to land safely at OR Tambo in the end. Very volatile shares, with big swings above and below the average, are considered risky. They can offer nice big returns, but you risk losing part of your initial investment if you’re forced to sell during a low due to panic or time constraints. And that brings us to… - Your time horizon
A time horizon is the period you can be parted with your money before you need to take it out of an investment. If you’re saving for retirement, your time horizon is probably in the decades. You can wait out any big dips, which means you can also afford to have a few more volatile shares in your portfolio. If you’re simply parking R10k that you need to withdraw in six months to pay Phillip your wedding photographer, then you risk being forced to sell at a low price. You might be better off putting that money into a savings or money market account, rather than volatile shares.
Systematic risk vs unsystematic risk
Quick vocabulary lesson. There are a lot of different kinds of risk – from an individual business’s operations risk, to country risk, when a whole nation can’t honour its financial commitments – but they all fall into the category of either systematic risk or unsystematic risk.
Systematic risk affects the entire market. You can’t diversify away from it, because every share is down. (Think: 2008.) Rest assured, nobody else is having any fun, either.
Unsystematic risk applies to a specific company or industry. For example, if Elon Musk tweets (or Xes?) something deranged, Tesla (TSLA) stock may take a knock but it won’t impact the entire NYSE or even the larger automotive industry. If you’re a Musk stan with a large appetite for risk, maybe you go all in on TSLA stock. That’s an unsystematic risk. We hope it pays off for you.
Nothing ventured, nothing gained
Of course, the riskiest thing you can do for your financial future is not to invest at all. Don’t bury your head in the sand, and – please – don’t stuff your savings under the proverbial mattress. Take on as little or as much risk as you are willing and able to, and just get started.
Shyft allows you to trade top global stocks and ETFs right from your phone, at any time of the day and with no commission fees or paperwork. You can view detailed information on each product, including tracking its performance over 72 hours to 18 months. It’s a great way to practise balancing risk and reward.
Get working on your portfolio right now.
