Investing basics: risk, return and time

Investing means putting money into something you expect to grow in value or pay you an income. It can build wealth over time, but it always comes with some risk.

The main types of investments

Investments are often grouped into “asset classes”. Each behaves a bit differently.

“Growth assets” (shares and property) can rise more over time but can also fall sharply. “Defensive assets” (cash and bonds) are steadier but usually grow more slowly.

Risk and return go together

Return is what you earn from an investment. Risk is the chance you get less than you expected, or lose money.

The two are linked. If something offers a higher possible return, it almost always carries a higher chance of loss. Anyone who says you can get high returns with no risk is wrong, or trying to scam you.

Risk also includes:

• Inflation risk: your money grows more slowly than prices rise, so it buys less.
• Liquidity risk: you can’t sell quickly when you need the cash.
• Timing risk: you have to sell when prices are low.

How compounding works

Compounding is when the returns you earn start earning returns of their own. Over many years, this snowballs.

The earlier you start, the more time compounding has to work. Even small, regular amounts can add up.

Time in the market

Markets go up and down, sometimes a lot. Over short periods, growth assets can lose money. Over longer periods, those ups and downs have historically tended to even out, though past results don’t promise future ones.

That’s why many people only put money they won’t need for five years or more into shares or property. If you might need the money sooner, a fall at the wrong time could hurt.

Trying to “time the market”, by buying just before prices rise and selling just before they fall, is very hard. Even professionals often get it wrong. Many investors instead invest regular amounts over time, which means they buy some when prices are high and some when they’re low.

Diversification: don’t put all your eggs in one basket

Diversification means spreading your money across different investments. If one does badly, others may do better.

You can diversify:

• across asset classes (cash, bonds, property, shares)
• within an asset class (many companies instead of one)
• across industries (banks, health, technology, mining)
• across countries (Australia and overseas)

Diversification can’t remove risk completely, but it reduces the damage any single investment can do.

Know your risk comfort level

Before you invest, think about:

• Your time frame. When will you need the money?
• Your reaction to losses. Could you watch your investment drop 20% without panic-selling?
• Your other money. Do you have an emergency fund and manageable debts?

Remember your super is already invested, often in a mix of shares, property, bonds and cash. It’s part of your overall picture.

Next steps

1. Check how your super is invested and what investment option you’re in.
2. Use a compound growth calculator to see how regular amounts could grow over time.
3. Read the guides on shares and ETFs, and on managed funds and fees, before choosing where to invest.