What is a risky investment?
How many of us believe if a bank promise us they will pay us a FD rate of 2%, they will actually pay us 2%? I do. In fact if the risk assessment here is whether the bank pays us or not pay us, the answer is a simple one. There is really virtually no risk at all. The bank will definitely pay us.
Let’s look at an actual definition of risk in financial terms yeah.
What is Risk? According to Investopedia, this is the definition of, ‘What Is Risk?’
Risk is defined in financial terms as the chance that an outcome or investment’s actual gains will differ from an expected outcome or return. Risk includes the possibility of losing some or all of an original investment.
Risk is beyond whether we will get / not get the promised return yeah
After misses as well as gains in all my investments throughout the last 18 years, I personally believe we need to move beyond the high risk, high return and low risk, low return financial thoughts. Look back at the Fixed Deposit example above. If the FD rate is 2%, would we face any risk at all that the bank will not pay us this return? Of course not. However, does this mean FD has NO RISK then? In financial term, it’s virtually no risk.
In real life however, I give you two important reasons why FD will now be ‘risky’ moving forward.
#1 FD Rate is really, really low and it is expected to be low for a long time to come. There were times when FD rates were way higher. Maybe 2 times, 3 times higher than what we have today. If FD rate is 7%, it meant that what we have in the bank will double every 10 years! Assuming we work from 25 to 55, that’s 30 years and there’s a chance your money will triple! Or at least double. Not today. FD rate is 2% today. Your money will only double in 36 years. In other words, by the time you stop working, your money has not doubled…yet.
#2 It’s worst than not having the returns after 12 months. If we bought a stock with high risk and it has a potential high return, we may lose a lot or we may gain a lot within a period of time. Let’s say it is 12 months. This meant that in 12 months, if we lost a lot, then we can start to think of ways to restart. Unless of course we put in all our savings, else, very soon, we can restart. Now imagine if we did not do anything to our money and everything was in FD until they day we retire… There is no way to restart. By then, we could only try to minimise our expenses instead.
Please understand that risk is not just about returns anymore
With a low interest rate regime and expectations that this will continue (if we refer to all the advanced economies for some clues), riskiness moving forward is really about earning too low interest for too long a time. This is the risk which we must also understand moving forward. If we did nothing and everything seemed safe and we continue to earn low returns year after year, that would be the riskiest of all. Happy understanding and all the best in trying to get higher returns year after year.
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