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Risk and return – The trade-off

Following the recent cut in official interest rates, it is to be expected that interest rates on bank term deposits will also be reduced. Falling interest rates can often tempt investors to chase higher rates elsewhere.

Caution needs to be exercised as there is always a trade-off between risk and return. As a general rule, the larger the potential investment return, the higher the risk. All investments, including shares and interest paying investments carry a degree of risk. The recent collapse of the Banksia Financial Group is a reminder of the risk associated with higher interest paying investments. Banksia, as a non-bank lender, offered investors high interest on debentures and then lent these funds out as mortgages or commercial property loans. However, as Banksia did not hold a banking licence, the funds in the debentures were not backed by a deposit guarantee. This is particularly disappointing for investors who didn’t understand the risks.

Whilst there may always be that one investment which fails completely, there are ways of trying to mitigate overall risk of your investment portfolio. These include:

  • diversifying your investments across different asset classes and institutions, in other words "not putting all your eggs in the one basket" and
  • appropriately matching the length of time you want to invest for with your tolerance for fluctuations in returns.

Of course borrowing to invest will always magnify any losses, as the debt still has to be repaid if the investment falls in value.

If you are concerned that your portfolio does not match your tolerance for risk, or would like to discuss your risk profile, investment timeframe and current financial situation, please contact your Saward Dawson advisor or our financial planning specialists, Vicki Adams and Cliff Dawson.

 

Vicki Adams is an Authorised Representative of Count Financial Limited (Licensed Dealer in Securities) Australian Financial Services Licence Holder Number 227232.

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