Risks and rewards
As a general rule of the thumb, higher risk means more reward. This is because people demand to be paid more when there’s a higher chance that they’ll lose some of their money. On the other hand, if there’s a lower chance of losing some of your money, you would accept lower returns in exchange for the certainty.
You can look to your bank for a good example of this. When your money is in your chequing account, it earns an interest rate of approximately ¾ of basically nothing (technical term). But if you put it in a term deposit, you’ll get paid a higher interest rate. This is because you’re taking a small risk. If you need to take the money out of the term deposit before the term is up, you’ll pay a fee, and end up losing some money. So the bank is compensating you for this risk with a higher interest rate.
The same concept applies to investments through Sharesies. Some investments pay off more in the long run, but they go up and down a lot more in the meantime. Others grow slowly, but don’t go down in value as often.
The best way to figure out how much risk to take is to look at your investment horizon.
“Investment horizon” is one of those fancy investment terms that takes the long way round to describe something straightforward. In this case, it’s a timeframe. Your investment horizon is just the amount of time you expect to go by before you actually spend your money.
This obviously doesn’t need to be exact, as that would be impossible. But you should know whether you’re going to want to spend your money next week, next month, next year, or in the next few decades.
If you're going to need your money soon, you should probably avoid riskier investments. These investments tend to pay off more in the long run, but they also have a tendency to going up and down a bit in the short run.
Here’s an example: say you bought $100 worth of US500 shares back in May. In May, they were worth $6.44 per share, so you would have got 16 shares (we’re rounding up).
Those shares are now worth $6.91, so if you sold your shares today, you’d have $110. Nice!
But wait—what if you had a very short horizon, and sold your shares in August? Things were not so rosy back then, and shares were only worth $6.05 each. Your $100 would have been worth $97. You lost $3. Stink.
This shows that your time horizon matters. If you’re not selling when your shares are worth less than you paid for them, then you’re okay. But if you need the money, and need to sell when your shares are not worth very much, then you’re going to pay a steep price for your risk. So make sure you tie your level of risk with your time horizon. Longer horizon = more risk.
So that’s really it: investing is about risk and time. The more time you have, the more risk you can take. And the more risk you can take, the higher you should expect your returns to be to compensate for that return. Another reason diversification is so key! So buy, hold, and wait to get the rewards.
Ok, now for the legal bit.
Investing involves risk, including the potential loss of principal. The info provided above isn’t a recommendation to buy, sell or hold any financial products available through the Sharesies platform. Before investing, consider your investment objectives and read the information provided in the product disclosure statement carefully.