Investing Basics

Module 1

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Investment Risk

Investment Risk

When you take the decision to invest your money, it is likely that you are going to take a risk. Whether this risk is big or not, depends on the type of investment that you make.

Some investments come with very little risk at all and are usually offered by governments. The investments offered by the government are considered to come with almost no risk as they are guaranteed. This essentially means that should anything happen, the government promises to cover the money that they owe you.

With there being little to no risk in those investments, the returns offered are very small, usually ranging from around 0.5% to 1.5%.

Meanwhile, stocks are considered to be one of the riskiest types of investment. The annual return that an investor can expect to make from stocks ranges from (7% to upwards of 30%). With stocks being much more risky, there is also a larger chance that an investor will lose money or generate a very small return.

This illustrates a key relationship between risk and reward in investments. The more risk that you take on, the greater the reward that you should expect.

Provider Risk

Investment risk is not the only risk that an investor should anticipate. Provider risk is another key risk that investors should bear in mind.

Provider risk refers to the chance that your investment provider gets into financial difficulties, putting your investments at risk. If your investment provider gets into trouble, there is not always a guarantee that you will receive all of your money back.

With that said, in many countries there are regulations in place that protect investors from not having access to their money, if their provider goes bust. For example, in the UK, investments up to £85,000 are covered by the Financial Services Compensation Scheme.

Investment companies that offer investment services in the UK are required to contribute towards this scheme, ensuring that investors are able to receive a portion of their funds back should anything go wrong.

When picking the company that you intend to invest with, it is important that you pick a company that you trust. It goes without saying that doing extensive research is recommended.

Although it is down to personal preference, it may be better to invest with a company that has a long track record. Newer companies may not have a lot of experience and may not be able as reliable.

Most importantly, ensuring that an investment company is regulated can often help to protect your money against provider risk.

Investing in other countries

Earlier, we highlighted that investments offered by governments are typically seen as having little to no risk. This is typically only the case in developed nations, like the United States or the United Kingdom.

Investing in countries that have a less stable economy, may result in it being less likely that your money is guaranteed.

This would especially be worrying if you invested in a country that you couldn’t speak the language in or didn’t understand how their systems work. If you can’t easily navigate within a particular country, it may mean that your money is not recoverable.

Certain countries, who are experiencing economic difficulties, are often very attractive to investors as they offer high returns (i.e. the Turkish government currently offer a 26% return on their bonds).

However, such high returns may mean that the government default on their debt to you, with the outcome being that you do not receive your money back.

In addition to government investments, investing in foreign stocks can be a challenge too. This is because many foreign countries have little financial regulation or have under-developed systems.

For example, if you invest in the stock market of smaller foreign countries, it may be challenging for your stockbroker to receive dividends or to locate your money after selling your stocks.

So, when investing in other countries, consider whether those countries are reliable and if they have a developed system that will be easy to use.

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