Every investment comes with some level of risk, and risk can have a negative connotation. When thinking about risk, you should consider your willingness to accept risk, sometimes referred to as risk tolerance, and your ability endure potential financial loss, sometimes referred to as risk capacity. Your personal financial circumstances, including need for liquidity, amount of debts, your income and what assets you have will impact your overall risk profile.
Often, when investors think about risk, they think about terms of the chance they might lose money. In this context, avoiding risk may seem like a natural defensive action to take, but it can also inadvertently introduce new risks that can affect your ability to achieve your financial goals. Your expectations for returns may conflict with the level of risk that you are willing and able to accept for your investments. If you have unrealistic expectations as to expected returns given the amount of risk you are willing to take, you should seek to better understand the relationship between risk and return. However, you should not invest in higher risk products that are unsuitable for you. Discuss with your advisor or examine further what is the relationship between risk and return to address the mismatch and establish realistic expectations of returns and potential types of investments, in light of your risk profile.
If you are a very conservative investor who is only willing to invest in guaranteed investments and you do not have the capacity or tolerance to sustain potential losses and volatilityVolatility The rate at which the price of a security increases or decreases for a given set of returns. A stock price that changes quickly and by a lot is more volatile. Volatility can be measured using standard deviation and beta.+ read full definition associated with even a moderately conservative risk portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition, then you may need to reassess whether your goals or return objectives can be achieved and whether you will need to save more, spend less or retire later.
Financial literacy and risk
Trying to avoid risk has its consequences as it exposes investors to other challenges, like inflation risk. While investments like GICs and money marketMoney market Low-risk investments that mature in less than three years and are very easy to turn into cash. This includes short-term GICs, bonds, and treasury bills.+ read full definition funds can be comforting to investors by assuring them safe and stable returns, those returns may be below inflationInflation A rise in the cost of goods and services over a set period of time. This means a dollar can buy fewer goods over time. In most cases, inflation is measured by the Consumer Price Index.+ read full definition resulting in a decline in purchasing power. Deciding not to invest exposes you to this same risk.
Not being willing to accept even a small level of risk could make it more challenging to achieve your goals. Being overly conservative in your investment decisions could mean you may not make enough money to meet your investment goals or will need to invest a larger amount per year, will end up with a smaller amount to live on when you reach retirement, or will need to work longer before retiring to accumulate sufficient savings.
Investors with larger portfolios are more likely to have a risk profile that permits them to take on more risk in order to provide a higher growth potential or greater expected returns. In the 2020 OSC Investor Experience Research Study over 40% of investors with more than $500,000 in assets indicated that they were willing to accept a moderate level of risk and tolerate moderate losses to achieve potentially higher returns.
Different levels of risk
Generally, the higher the risk, the greater the chance of a loss, but it can also mean a greater potential return. As an investor, it’s important to invest in a diversified portfolio, and not put all your eggs in one basket. In this way, you can help to mitigate the risks associated with market volatility, as all investments don’t tend to go up and down at the same time or by the same amount.
A key consideration when determining your risk profile is your time horizonTime horizon The length of time that you plan to hold an investment before you sell it. This may be a brief period of time or span as long as decades, depending on your financial goals.+ read full definition: the length of time over which you expect to invest your money. The more time you have to reach a financial goal, the more risk you can typically afford to take – because you have more time to recoup potential losses. For near-term goals, investors may want to lower their risk. Lower-risk investments like high-interest savings accounts, guaranteed investment certificates (GICs) and money market funds can be easy to convert into cash when needed. They are ideal for short-term goals because they protect you from losses while still earning a moderate return.
When building your portfolio, understand the risk-return relationship and your ability and willingness to tolerate risk. This will help you decide your asset mix and how much to hold in various investments, such as equities, bonds or cash.
Use this chart to see the risk-reward trade-off of different types of investments.