HIS parents have been warning of the risk in investing. “Sam, we’ve lost all our hard earned money in the stock market. The safest place is to keep all your money in the bank account.”
HIS parents have been warning of the risk in investing. “Sam, we’ve lost all our hard earned money in the stock market. The safest place is to keep all your money in the bank account.”
This begs the question: “Are bank savings truly risk-free?”
In our view, the answer is – not necessarily. Even if savings or deposit accounts lack the volatility risk, they are not safe from the often overlooked and under-estimated threat of inflationary risk.
Notice how we differentiate the word, “risk” into several distinctions – volatility and inflationary?
What is risk?
To think that risk represents the potential downside of an investment would be merely scratching at the surface. We have to look at risk from a broader perspective.
Risk can be defined as the possibility of not achieving an objective. So the next relevant question to ask is “what then is your objective”.
If Sam’s aim is to achieve financial freedom by age 40 with a normal-paying nine to five job without an interest in starting his own business, remote possibility of receiving an inheritance while merely putting all his hard-earned money in the bank savings, he then risks achieving that goal.
In the investment and finance context, risk will always be an ever-present component. What we need is a proper understanding of the various types of risk and managing those risks.
Danny Wong Teck Meng
There is a broad range of risks out there but we will try to list a few of the more commonly known ones here:
This means that a fall in the broader capital or financial market whether on a local or global scale could negatively affect the value of investment.
In layman terms, if property prices fall across the nation, that beautifully-maintained house in a prime location will inevitable fall in price as well. Much like how a fundamentally strong stock would in a market downtrend.
But if the owner of the house has no need for cash during that time, why should he be forced to sell when prices have temporarily dipped? For wise and long term investors, a downtrend may even be their cue to buy.
This refers to the ease of liquidating or selling an asset. If that particular investment is illiquid, it may take a while to sell the investment or to receive money from that sale. Besides that, you may also be forced to sell at an unfavourable price.
It is the risk that the investment returns may not keep pace with inflation. If the inflation rate is running at 5% per annum while the returns on your investment is only generating 3%, it means that your capital is being gradually eroded. Your cost of living will increase as your purchasing power becomes reduced.
In our next article, we will discuss one of the common myths in investing – “Does high risk mean high returns?”
Danny Wong Teck Meng, CFP is the CEO of Areca Capital Sdn Bhd and a certified member of the Financial Planning Association of Malaysia (FPAM).