Assessing risk in investing
Investing at its very core is simple. It’s all about risk and returns. How much of an incremental euro are you willing to risk to gain a euro.
- Rule 1: Don’t lose money
- Rule 2. Don’t forget rule number 1
Risk is thus defined by how different the returns are, not losing money.
To further explain, risk is the uncertainty of a loss; you could lose your capital on an investment.
Stocks and shares, whilst being riskier than government bonds, typically accumulate higher returns in the long term. How much risk is associated amongst stocks and shares varies a great deal.
Stocks are riskier when their valuations are high.
Stock markets have convinced us that to minimise risk, and we should invest our money in well-managed hedge funds.
Naturally, these funds require investors to pay fees to manage them. Thus profits, whilst generally higher, will only be made once fees have been paid.
You could argue that this is simply a measure that the stock market invented to sell you more managed hedge funds.
Short-term and long-term considerations come into play when assessing risk. Short-term wise, breaking even is an end goal for evaluating risk.
However, most investors strive for the long term and should consider two critical factors: inflation and liabilities.
Inflationary effects are minimal in the short term. Still, it does matter in the long run because losses from inflation will compound over time.
Turning to liabilities that grow over the long term, funds like pension plans, life assurances and endowments have liabilities they need to fund. Individuals are impacted by the obligation to meet retirement goals and family responsibilities.
The risk, therefore, represents the uncertainty of a shortfall in achieving the projected liability – the end goal.
Rather than recovering their investment, investors should assess the probability of achieving the required rate of return – their end goal.
In essence, what amounts to low-risk is different to one investor than another. The difference is not surrounding what constitutes high returns but the end goal for the principal investment.
Four examples of low-risk, high-return investments
1. P2P loans
P2P investing has become one of the fastest-growing alternative investment vehicles providing investors with diversified portfolios and delivering high returns.
With most platforms providing various capital protection, including buyback guarantees, guarantee funds and a voluntary reserve, the risk to investor funds has been minimised.
Coupled with the steady income returns, make P2P loans a sturdy investment for those seeking lower risk to their capital.
Typical P2P loan rates of return can range between 6% and 20%, even once you subtracted management fees.
Property investments can leverage high returns through rental income, appreciation, and profits generated by business activities that depend on the property.
Other returns are through tax advantages and lump sum returns should investors sell the property concerned.
Property investment trusts offer an alternative way to invest in property without owning, operating, or financing properties, thus removing the hassle of property management.
Residential rental properties, for instance, have an average return of 10.6%. Commercial property, on the other hand, has an average return on investment of 9.5%.
Timber has been a favourite alternative investment of investors for over a decade now. The best part about timber is that you don’t do anything. Every year the tree grows, you make 2-4%, assuming constant timber prices.
The best part is that you don’t have to sell when timber wood matures for harvesting. Investors can hold their timber investments until they are happy with current timber prices to sell. Typically, timber prices correlate with the housing market.
However, they are not related to the stock and bond markets, providing relief should there be a stock market slump and offer returns around 7%.
4. Rare coins and precious metals
Similar to timber, buying precious metals like gold, silver, or rare coins. Rare coins and precious metals are not as closely related to the global economy’s performance as the stock market is.
Precious metals and rare coin prices are often closely tied to the price per ounce of gold and silver rather than any other index.
Because of this, rare bullion coins are generally considered one of the less risky investments on the market. Precious metals prices range on an average yearly return of 3-4%. Sometimes prices hit decade highs of 15-20%.
Several alternative investments are a lot less risky than investing in stocks and shares, bonds and mutual funds.
Additionally, the returns they make are usually more significant.
Investors have more control over alternative investments, which provides a higher safety net because of this control.
In summary, don’t let the stock market define risk for you.
Taking on more risk does not necessarily equate to higher returns. The causality could be the opposite; investors demand higher returns for shouldering more significant risk.
Low-risk, high return investments aren’t a myth – they merely require a reassessment of an investor’s end goals.