Understanding the basics of investment

Standard Chartered Bank

Get off to a good start

Before you embark on any savings and investment planning, you first need to understand the basics. It’s a lot like cooking – where to get the best results, it’s vital for you to know the different kinds of ingredients and how they interact with each other.

To help you get the best recipe suited to your needs and tastes, it’s worth taking the time to understand the principles of investing. And whether you choose to take more risks or prefer to save your money carefully, the financial institution can recommend the
best choice.

Understanding risks and returns

Virtually all investments have risk; you could lose all or part of your money. Even if you decide to keep your cash under a pillow, you’re still subject to the risk of inflation; which is why understanding the relationship between the risk and return of an investment is one of the key steps to successful investing.

The higher the return, the more risk you have to accept. Typically, investments such as bonds are relatively lower in risk and experience relatively smaller price fluctuations. Then there are equities (or stocks), which can dramatically go up or down in price.

So, if you desire higher returns, you must be prepared to accept higher risks. It comes hand in hand with the prospect of making money.

The different flavours of risk

Now that you know you have to accept some risk to get more returns for your money, the next step is to understand the different types of risk. Knowing whether the risk can or cannot be reduced may help lessen the risk in
your investments.

1. Systemic risks

These are risks you have no control over, including

– Market risk

– Global instability

– Interest rate/inflation risk

For example: Global financial crisis, political instability, pandemics, natural disasters, etc.

2. Non-systemic risks

These are risks you can potentially reduce through diversification of your portfolio including:

– Geographical risk

– Sector risk

– Company risk

For example: Quality of a company’s management

The right mix to meet your goals

Knowing which ingredients to use is one thing; but getting the right balance for a successful recipe is a fine art in itself!

By now you should understand the relationship between risk and return, as well as the different types of risk. But whether you like it hot and spicy or safe and secure, you should maintain a diversified portfolio to get the best results for your investing recipe.

Ideally, the best recipe for a portfolio is one where you trade off some return for a large decrease in risk. This is the essence of diversification.

Giving your investments time to cook

Time is an important factor in any form of preparation. When it comes to cooking, you’ll want ample time to prepare or you could risk undercooking or burning your food. Likewise, with investment, you don’t want to rush.

So just how much of a time horizon do you need for your investments? It all depends greatly on what your financial goals are and when you need your money.

Research has proven that investing over a longer timeframe is one of the key ingredients for a sound investment recipe. This is because over time, the highs and lows will average out, and hence, you’ll get a better overall return.

How much do you need?

It may seem like common sense, but so many of us forget this piece of advice; you should never risk investing more than what you can afford. Here’s a simple example to illustrate the point.

Regardless of how much money you think you can risk, it should be based on a realistic assessment of three thing – your current financial situation, age and investment time horizon.

It’s a wiser move to first cover your basic needs for the present and future, before you think about taking more risk with your money.

If you find that you don’t have enough to realistically cover those needs, you should lower your risk appetite and opt for  safer investments.

This article is for general information purposes only and while the information in it is believed to be reliable, it has not been independently verified by us. You are advised to exercise your own independent judgement with the contents in this article.