Striking the balance between risk and return has always been a puzzle for novice and seasoned investors. Once you achieve the balance, you can maximize your returns and potentially compound your earnings to gain more profit. To do so, you’ll need to understand your investment goals.
This guide will serve as your roadmap to this balancing journey and how risk and return are intertwined in the story of three friends who started their investing journey.
Introduction to risk and return in investing
The risk-return relationship can shape the outcome of any investment strategy. Risk, in general, refers to the likelihood the outcome will differ from expectations. When it comes to investing, it is the volatility or fluctuations in the asset value over time. Return, on the other hand, is the prospect of gaining value on an investment. It is the reward investors anticipate for taking a particular level of risk.
An investment gain happens when there is a positive return on the money invested, while loss happens when there is a negative return on the money invested (if the investor sold their investment, they would receive less money than what they originally invested). In most cases, higher potential returns on an investment go hand-in-hand with increased risk.
However, not all investments carry the same level of risk. Some assets, like high-interest savings accounts and GICs, guarantee your initial investment (low risk) but with a predetermined lower growth in asset value, while others, like stocks and cryptocurrencies promise high returns but with much more volatility (higher risk).
Other investment types, like mortgage investing, can offer an attractive risk-return profile as they provide a steady stream of income through dividend payments with a potential for high growth through reinvesting, all the while offering security in the form of mortgages.
What are the three types of investor risk profiles?
Different individuals have varying appetites for risk. Age, financial goals, and time horizon are crucial in guiding the risk-return trade-off strategy.
Investors typically fall into three risk profiles: Conservative, Moderate, and Aggressive.
- Conservative investors are known for their risk-averse approach, prioritizing capital preservation above all else. They choose low-risk investments like government bonds, Guaranteed Investment Certificates (GICs), and money market funds, including cash and equivalent assets.
- Moderate investors seek a balance between growth and income while managing risk. They invest in a mix of bonds for stability and income, stocks for potential growth, and real estate and mortgage investments for a steady income stream. Moderate investors acknowledge that some risk is necessary to achieve higher returns; however, they value capital preservation more than aggressive investors.
- Aggressive investors are comfortable with higher risk for potentially more significant returns. These individuals are comfortable venturing into more volatile markets such as individual high-growth stocks, cryptocurrencies, private equity, or venture capital.
By understanding their individual profiles, investors can make informed decisions about their portfolio allocations. However, it is essential to note that a well-rounded portfolio comprising different asset classes can be crucial to achieving a balanced investment through diversification.
A Tale Of Balancing Risk And Return
Lifelong friends Jake, Luke, and Mia decided to make their money work for them by investing $10,000 at the start of the year. They explored their financial goals, realizing each had unique aspirations and time horizons.
Jake wanted to renovate his patio by the end of the year, so he saw investing as an opportunity to complement his savings. He chose a blend of high-quality government bonds, money market funds, and a conservative mortgage fund in his portfolio to earn some passive income while protecting his capital against market fluctuations. His initial investment of $10,000 had grown to approximately $10,700 by the end of the year, enough to cover the deficit of his savings for the renovation.
With dreams of starting a small business in the next 3 years, Luke adopted a moderate, balanced stance. Diversifying his $10,000 into a mix of stocks, income mortgage funds, and bonds, Luke sought a balance between risk and return. His strategy aimed to capitalize on market opportunities that provided steady growth and income, which aligned with his medium-term horizon. By the third year, his initial investment grew to $13,500 which he then used as capital for a food truck business.
Mia aimed for higher returns and enthusiastically embraced risk in her long-term goal of early retirement. Investing her $10,000 in individual stocks, high-potential assets, and a high-yield fund, Mia remained committed to her investment even through seasons high fluctuations. Her high-risk appetite reflected her long-term goal. By the tenth year, she raised the initial investment to approximately $35,000, which she continued reinvesting for years to come.
Note: Adapted from Morningstar. For illustrative purposes only.
The journey of Jake, Luke, and Mia showcases the significance of aligning investment strategies with individual financial goals, time horizons, and risk appetites. The diverse approaches they embraced—from conservative to aggressive—demonstrate the personalized nature of investing.
This also highlights the importance of diversification and reinvesting, particularly for those seeking a stable and consistent return. Reinvesting allows for compounding returns — when your returns (or interest) earn interest.
Exploring opportunities in mortgage investing, as offered by Amur Capital, can complement and enhance one’s overall investment approach.
Amur Capital offers three funds, each designed to meet the varying risk appetite of investors. The goal of each fund is to distribute 100% of its annual profits to its shareholders as flow-through investments, ensuring consistent returns and preserving their capital while also providing a stable passive income stream for investors across Canada.
Frequently Asked Questions
Generally, the higher the potential return of an investment, the higher the risk. However, there is no guarantee that you will get a higher return by accepting more risk.
Diversification, when done right, can help in mitigating risks. However, it is also important to consider your financial goals first, which will determine the appropriate investment that can give potentially higher returns while also managing your expectations.