Understanding Investment Risk

Risk and return

In general, investments that offer higher potential returns carry higher levels of risk. Cash and term deposits have historically offered lower returns with less variability. Shares and growth assets have historically offered higher long-term returns, with significantly more variability along the way. Private and early-stage investments may offer higher potential returns again, with greater uncertainty and the possibility of losing the entire investment.

This relationship is a tendency, not a rule. Higher risk does not guarantee higher returns — it means the range of possible outcomes is wider.

Market risk

Market risk is the risk that the value of an investment falls because of broad movements in financial markets, rather than anything specific to the investment itself. Economic conditions, interest rates, geopolitical events and investor sentiment all contribute. Diversification within a single market does not remove market risk, because most assets in that market tend to be affected at the same time.

Investment-specific risk

Investment-specific risk relates to a particular company, issuer or asset. A company may lose a key customer, face competition, take on too much debt or be affected by poor management decisions. This kind of risk can be reduced by holding a range of investments, so that the outcome of any one does not dominate the portfolio.

Liquidity risk

Liquidity risk is the risk that an investment cannot be sold or redeemed quickly, or can only be sold at a significant discount. Listed shares in large companies are generally liquid. Private company shares, some fixed term investments and certain unlisted funds can be highly illiquid. Liquidity risk matters most when an investor needs access to funds unexpectedly.

Private-market risk

Private-market investments generally involve less public disclosure, less frequent valuation and fewer ways to exit. Information may be harder to verify, and valuations may not reflect what a buyer would actually pay. These characteristics mean private investments often require greater due diligence and a longer time horizon.

Concentration risk

Concentration risk arises when a large proportion of a portfolio is exposed to a single investment, sector, issuer or market. A concentrated portfolio can perform very well or very poorly depending on the fortunes of a small number of holdings. Many investors manage this risk by setting limits on how much they allocate to any single position.

Timing risk

Timing risk is the risk that the point at which an investor buys or sells has a significant effect on the outcome. Investing a lump sum just before a market fall, or needing to sell during a downturn, can materially affect results. Longer time horizons and staged investment approaches are two ways investors seek to reduce the impact of timing.

Putting it together

Understanding risk is the foundation of a sound investment approach. Before making any investment, it is worth identifying which of these risks apply, how they interact with the rest of your portfolio and whether you are comfortable with the range of possible outcomes. This article is general information only and does not constitute financial advice.