There’s a lot of misconception about risks and earning returns in investment. Some people say we want to get returns but we don’t want to take risks while some say we need to make returns but we want guaranteed returns.
In this post, we’ll dive into the relationship between risk and returns and make it easier for you to understand.
‘Tobi is a civil servant working for the Lagos State Government. She knows that she needs to be putting aside at least 20% of her salary every month, and she recently learned that it’s best to invest in dollars with Rise and loves the idea. But something is mind boggling for Tobi – is it possible for her investments to be guaranteed in a way that she doesn’t lose any money? She knows she wants to grow her money but she doesn’t like the idea of her money being at risk.’
To solve Tobi’s puzzle, we need to understand the relationship between risk and returns. They are the Siamese twins of investing – you cannot have one without the other. To earn returns that increase the value of your money, you have to take on ventures that may not always succeed. This means your investments might not always pay off. That is risk.
Now, Returns. These are the profits you earn for taking a financial risk. Another way to look at it is, you earn returns when you are paid for taking on a risky venture. So if you want to make returns, you have to take the risk.
You or your investment manager must carefully evaluate and understand the risk you are taking. Ensure your prospective investment makes sense, the returns are understood and the possibility of a loss is reduced to its barest minimum. Investment involves taking informed and calculated risk, not just taking risks blindly.
This relationship between risk and return is why the safer the investment, the lower the return. Fixed income is generally safe because they have guaranteed returns and are based on the creditworthiness of the issuer. This is also why they tend to have the lowest returns.
Stocks, on the other hand, move up and down a lot, and you can lose money just as easily as you can make it. But in the long term, stocks have the highest returns of almost all other assets. So if higher risk equals higher returns, that means that the higher the return on an investment, the riskier the investment.
This is why if an investment promises a return that is too high (say 100% in 6 months) it’s probably too risky and should be avoided. And investments that promise 30% in a single month (almost 2,300% in one year) like all these forex “investments” should definitely be avoided as they’re likely too good to be true.
That said, our advice to Tobi would be to make sure she asks the necessary questions and understands how Rise generates returns and then go ahead and invest because while the risk is ever present, it’s also the only way to generate long term returns that will help her retire financially free and well off.
Take away: Returns follow risk. To grow your money in the long term requires taking some risk and investors have to accept the possibility their investments may lose money. But in the long run, taking calculated and informed risk is the only way to grow your money without worries.
Pro Tip: Treat the money you invest like an expense. If you’ve spent it it’s gone. But if it comes back with returns in the future, you’re better off.