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With inflation at levels not seen for decades, it is now more important than ever to know how to invest money. Because, as you may have noticed, we are all losing purchasing power.
Salaries are not going up much, but the rise in the CPI (Consumer Price Index) is causing a large increase in the price of the basic products we put in our shopping basket. And to this we must add the increase in the price of electricity and gas. Not to mention gasoline.
This complicated situation makes it more necessary than ever to look for alternative ways to grow your resources. For example, through passive income and investment. But how to invest if you don't want to take too much risk? We tell you all about it here.
What you should know before investing your money
Investing is, in short, the process of buying assets that increase in value over time and provide returns in the form of income payments or capital gains. Broadly speaking, this practice can be viewed as an outflow of capital that is made in the present to improve personal and family financial health in the future.
Is there such a thing as a risk-free investment?
No, absolutely not.
Even if an investment is risk-free, we will always have the risk of inflation. It is only logical that investments that are presented as "safe" will fail to outperform inflation.
In reality, risk is an inherent part of every investment. There is no investment without risk; and if it had no risk, it could not be considered an investment. Logically, the higher the risk, the higher the required return investors will ask in order to invest.
The fact that there is always an inherent risk in investing money does not mean that there are no investments that are safer than others. Although risk is always present, it may be higher or lower.
But how can you know when an opportunity has higher or lower risk?
What is investment risk?
An investment risk can be defined as the probability that a return will be less than expected. In simple terms, it would be that the investment made does not provide the expected return or that the loss exceeds the initial investment.
Taking this definition as a basis, we can mention that every investment entails a risk, however minimal it may be, and that the greater the risk, the greater the level of expected return should be.
There are three levels of risk when it comes to investing
- Low risk
It is one that has little probability of representing losses or non-payment. Some of the investments of this type can be with the government or with banks, since they are institutions with low probabilities of failure in comparison with other issuers such as a person or company.
- Medium risk
This level provides considerable returns, but also implies a greater commitment on the part of the investment operation due to the fact that it is willing to expose more of the invested capital. Some examples of assets of this type are debt or real estate bonds.
- High risk
This level of exposure provides higher returns in exchange for assuming greater volatility. Therefore, the risk of non-payment or bankruptcy is more latent but returns tend to fluctuate more. When choosing this type of investments, it is advisable to have more knowledge and temperament, in addition to being very active when investing and having a loss containment strategy. At this level are stocks, currencies or derivatives.
5 Strategies to reduce investment risks
One of the main keys to managing investment risk is to be aware of how to do it. In words of Benjamin Graham, the father of value investing: “Successful Investing is about managing risk, not avoiding it”.
Here are 5 ways to reduce your investment risk:
- Have a diversified portfolio of investments
Diversification is the same as 'don't put all your eggs in one basket'. Investing in a variety of assets and industries, including stocks, bonds, time deposits, savings accounts and residential or commercial property means you're not overly exposed to any one market. Spreading your investments across different asset classes means that a drop in the value of one investment won't lead to your (complete) financial ruin, as you would have other investments to fall back on that could have increased in value with the same economic event.
Also, don't be afraid to think outside the box. Research from finder.com.au found that only one in six of us plan to use alternative investment options over the next 12 months. This leaves the market wide open for risk-tolerant investors to take advantage of non-traditional investments, such as automated advice or peer-to-peer lending. Just be sure to do your research and be aware of the (new) risks involved!
- Understand your risk tolerance
Risk tolerance refers to an investor's ability to bear the risk of losing their invested capital. Risk tolerance depends primarily on the investor's age and current financial obligations. For example, if you are young, single and have fewer financial responsibilities, then you are more risk tolerant compared to other investors who are in their fifties, married and have children going to college. So, as a general rule, younger investors are more risk tolerant than older investors.
If we start investing early in life, we can begin our investment journey with an investment portfolio that has pure capital that is primarily focused on aggressive wealth creation.
- Set investment goals
Defining clear personal and financial goals will help you decide which assets to invest in. In case you are saving for a vacation, it is better to invest in something low risk. This way you don't risk losing everything just for a getaway. If you are thinking longer term and want to make a profit for your retirement (in the form of additional contributions), then you can probably opt for a higher risk investment that will generate a higher return. Thus, if the value of the investment suddenly drops, you would have more time to wait for its value to increase again.
Setting goals will also help you determine your appetite for risk. If you don't think you have the scope to manage a loss on your investment, then make a low-risk investment, even though it probably won't have a high return. Once you become familiar with fluctuations in the market, you may be more prepared to take on higher risk investments that also have higher returns!
- Maintain sufficient liquidity in your portfolio
Beware, a financial emergency can come at any time! Therefore, we have to bail out our investments at any time, even when the markets are down. This risk can be reduced if we maintain adequate liquidity. If we have liquid assets in our portfolio, our current investments can offer optimal long-term returns and we can benefit from any periodic market corrections.
One of the ways to keep sufficient liquidity in the portfolio is to set aside an Emergency Fund that should be equal to 6 to 8 months' expenses. To ensure easy accessibility to emergency funds, we should have low-risk investment options such as Liquid Funds and Overnight Funds in our accounts. Once we have determined our risk tolerance and set aside some money to ensure adequate liquidity in our portfolio, it is time to determine an asset allocation strategy that suits us.
- Professional support
Asking professionals for help is always going to be necessary, especially if you are a person who is just starting out in the investment world. Another option is to find a company that offers you help and mentoring in their services.
Rizeapp offers something that many need in today's investment environment: Financial wellness through meaningful, real-time mentoring and guidance.
By analyzing and understanding your financial behavior, our AI coach helps you achieve financial well-being and increase your lifetime value.
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