There was a time when trading on an exchange, especially a commodities exchange, meant a physical exchange trading floor, which was often a loud, chaotic, high-energy environment that not a lot of people could have access to or even understand.
The world of investment at this time was shrouded in a lot of mystery, moved slower and was certainly a lot more exclusive.
Access to markets and opportunities at the time was determined by levels of intermediaries, and being able to quantify risk and reward was a tall order that could be deciphered by few true experts.
The digital age brought about a lot of changes in the world of investments, opening up opportunities to a wider group of individuals, but this, of course, meant that some new investors were able to participate despite not having a good understanding of risk.
Different investments carry varying degrees of risk, and by understanding risk and making decisions based on that knowledge, investors are better able to make the best decisions for their portfolios and eventual finances.
Most investments are already codified at different levels on the basis of the relationships or trade-offs that can be made between safety, potential for returns, and the liquidity of the platform or asset. Investors need to be able to know and be honest enough to align their choice of a particular investment with their financial goals, risk tolerance, and the time horizon that they can afford to leave their committed money alone for.
Considering this, investments can be:
- Low Risk: With a focus on preservation of capital above everything, returns are likely to be below or near inflation and so categorically low. It is also expected that volatility in price movements is minimal.
- Medium Risk: Likely carrying higher return potentials than low-risk investments, but also predicated on the expectation of some price fluctuations and volatility.
- High Risk: Greater volatility and a high chance of loss of capital hems in the potential for high returns, and a longer time horizon is often standard here.
- Speculative: A step above even high-risk investments in the potential for extreme gains or losses, and underlying principles for the investment types are often not based on fundamentals but rather on sentiment or news.
These risk categories can be identified among different asset classes; for instance, treasury bonds and money market funds are often inherently low risk, while growth stocks and Real Estate Investment Trust (REITs) are often high risk. However, even within asset classes, it is useful to consider the instrument. The commodities market, for instance, has examples at each risk level:
- Physical precious metals or commodities ETFs backed by physical assets are considered low risk.
- Diversified commodities ETFs that track a basket of different commodities can be considered medium risk.
- Options on commodity futures, which are a complex and time-sensitive product category, are definitely high risk.
Luckily, alongside opening up the investment landscape for a lot more people to participate, the digital age has also opened a lot of opportunities to learn about a product prior to making a decision. So, alongside the great advice to diversify your portfolio, being intentional about researching and understanding an investment before committing is another great move to manage investment risk today.
Here are a couple of things to ask and find out for yourself:
- What exactly is this asset class that I am considering for investment, and what are the typical risk characteristics of the class?
- How much does the price generally swing for the product or asset?
- How much could I possibly lose, and how quickly could this loss happen?
- What sort of trends or fundamentals generally cause a change in the instrument?
- How long can I leave my money locked into the investment instrument?
Understanding and managing risks make you a more confident investor over time, allowing you to take advantage of opportunities when they arise. Digital trading and investment platforms today often have a treasure trove of information and reports that can help anyone answer these questions and grow their understanding of the particular asset class as they continue to explore and improve their investment profile
