The risk-return relationship
Learn about 3 main types of risk and the relationship between risk and return.
To know your investing personality (step 2 to investing), you need to understand how much risk you can handle. Are you comfortable taking on more risk if it means your money might grow faster? Or are you more comfortable making less and knowing that your money is guaranteed to be there when you need it?
3 main types of risk
- Market risk – Investments decline in value because of economic changes or other events that affect the entire market.
- Liquidity risk – You can’t easily sell your investment and get your money out when you want to.
- Concentration risk – Concentrating your money in 1 investment or type of investment puts your money at higher risk. When you diversify your investments, you spread the risk over different types of investments, businesses and industries.
Watch this video
to learn how different types of risk could affect your investments.
Understanding risk and return
All investments have risk, but some investments are riskier than others – there’s a greater chance you could lose some or all of your money. In general, higher-risk investments offer higher potential returns, and lower-risk investments offer lower returns. For example, GICs and savings bonds have low risk because they guarantee that you will get your money back. But they also have a lower return than most other investments and may not keep pace with inflation.
Investments like mutual funds, bonds and stocks, may have a higher return over the long term, but their prices can change – sometimes by a lot. You could lose money. Other investments, like high yield bonds and leveraged ETFs, are highly speculative and are meant for investors who can afford to lose all of their money in the investment.
Keep in mind that risk and return are often affected by changes in economic conditions. And what seems risky to you may not seem risky to someone else.
Learn more about high-risk investments with this video