When you invest your money, you will always face some risk; meaning, there will always be a possibility of losing part or all of your money. There are no sure things in investing. However, different investments carry different amounts of risk; some investments are more risky than others. There is also a direct connection between risk and the profit, interest or earnings you can get from an investment. This connection makes up the most basic rule of investing:

When somebody offers you a “safe” or “secure” investment then you can assume that the profit or interest will not be that big. If somebody tries to convince you to put your money in a “safe” and “very profitable” investment, run! “Safe/secure” and “big profit” do not belong in the same sentence. Very high earnings are never guaranteed; if there’s a big possibility of earning huge profits there’s also an equal chance that you can lose your money.

The basic rule of investing is used to classify investments into:

1. Low-risk investment – the possibility of losing money is very small; sometimes referred to as secure, guaranteed or risk-free investment because it is almost impossible to lose money. This type of investment only gives a little profit or interest. Examples – time deposit & retail treasury bonds

2. Medium-risk investment – there’s a chance that you will lose some money although those that are managed well will often turn out a substantial profit especially over the long term. Examples – bond funds & balance funds

3. High-risk investment – there is a big possibility that you will lose a large portion of your money pretty fast (for example, losing 5% or more in one day); but if the investment turns out to be profitable, your earnings can also be quite huge in a short span of time (for example, 5% profit in one day). Examples – stocks, business

People have different tolerance for risk. What you may consider as risky, others may find secure and vice versa. Before you invest in anything, it is important that you know what kind of risk you are willing to take. If you are the type who cannot sleep at night because you are worried that your investment will drop 1% next week, then you have a low tolerance for risk and you will have more peace of mind if you put your money in secure investments.

Be aware though that always being on the safe side would mean you will have to set aside a bigger amount of money to achieve your goals compared to somebody who’s willing to take some risk. For example, to accumulate P1 Million in 20 years you need to save P3,046 monthly if you put your money in a time deposit account that pays 3% interest per year. If you invest your savings in a higher-risk mutual fund that earns an average of 10% per year, then you only need to save P1,317 monthly for the next 20 years to get to P1 Million (see table below). (Some small banks offer double-your-money time deposit accounts, which pay 12%-15% per year. For those who don’t like risk look for these TD accounts.)

If you are young and investing for your retirement, you will have to save almost 7x more if you put your money in a low-risk, low-interest investment account instead of a high-interest investment that carries some risk (P1,080 against P158 monthly). Kaya mahalaga na kayanin mo ang kasamang risk sa pag-iinvest para mas malayo ang mararating ng iyong pera. The good news is, while risk cannot be avoided, it can be managed and there are proven strategies which help minimize your risk of losing money like diversification and cost-averaging.

Last update: August 11, 2008
Copyright © 2008 www.PinoySmartSavers.com All Rights Reserved