Column: Deciphering Investment Risk & Reward

[Written by Carla Seely]

Over the course of my 18-year career in the financial services industry I have met many investors and based on our conversations, I can confidently state that only about half of them actually know what they have invested in. However, what is even more alarming is, their incomplete understanding of the risks associated with their investments. Risk and reward are two key components in understanding the type of investment you should be considering.

Risk, in general, is defined as the possibility of sustaining a temporary or permanent loss. This is true in the world of investments. Investments that are termed “high risk” have a significant possibility of experiencing large swings in their returns. In the simplest of terms, risk is a measure of whether a surprise will occur––both positive and negative.

Individuals investing will have very different tolerances for risk, and their tolerance will change over their lifetime. In general, if an investor needs cash within a short period of time, then that investor should not put money into high risk vehicles. However, an investor who has a very long time horizon [the period of time until they need to access the money], should seriously consider choosing investments that offer the best possibility of good returns. The long time frame before that person needs the money offers the investment a chance to grow and any occasional downturns will most likely be offset by other gains.

Many investors understand the principles of diversification and risk well enough to know it is unwise to “put all of their eggs in one basket”. However many do not always know how to avoid this in practice. The most successful investors will tell you, diversification is key. A diversified investment portfolio not only reduces unwanted risk, but also contributes to a potentially more profitable portfolio. Having a well-diversified portfolio doesn’t necessarily mean buying a second investment; it means branching out into other asset classes.

As an investor you should always do your homework and never invest in anything that you don’t understand. The more you know, the better off you will be. This requires that you take the time to learn and pay attention to events that might affect you. You work hard for the money you make so it is equally important to work hard to understand how to make the most out of your investments. This also includes your company pension plan. Make sure you understand how your funds are invested and that your pension is complimenting your overall investment strategy.

Finally, it is imperative that you read the fine print. Make sure that you understand the restrictions and fees associated with your investments. Is there a minimum level at which you can invest? Is there a cost associated with buying into the fund [front-end load] or leaving the fund [back end load]? Is there a minimum commitment time or locked in period? What is the penalty for making withdrawals? How is the investment advisor compensated? Is the advisor paid a salary or commission or a combination of both?

There is no golden rule to investing; there is no right or wrong answer. The key questions that you must always ask yourself are “Do I understand what I am investing in?” and “Do I understand the risks associated with my investment?”

- Carla Seely is the Vice President of Pension and Investments at Freisenbruch-Meyer. If you would like any further details, please contact her at cseely@fmgroup.bm or call +1 441 297 8686.

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