Financial Literacy Investments

Understanding Risk: The First Step in Smart Investing

byDayna Chong
  • Sep 11, 2023
  • 7 mins
woman looking at her paper

Investing can be an exciting journey, a route to financial independence, and a way to grow wealth. But like any journey, it's essential to understand the terrain before you set off. One fundamental concept that every investor must grasp is risk.

Risk is an integral concept that signifies the chance of your investments not delivering the expected returns or even losing the original amount invested. In other words, it represents the uncertainty tied to the potential outcomes of an investment.

Before you start investing in Singapore, it's crucial to understand the various types of risk involved and how they might impact your investment strategy.

There are several types of risks that you could encounter when you start investing. Understanding these risks is the first step to managing them effectively.

1. Market risk

For starters, market risk represents the exposure of your investments to the numerous unpredictable factors that could disrupt the financial markets. 

Take for example, changes in interest rates, which are a critical part of market risk. When central banks adjust interest rates, the ripple effects can be felt throughout the economy. It changes the cost of borrowing money, influencing how much consumers spend and how businesses invest. These shifts can impact the overall market environment, affecting the value of your investments.

Equity risk is another key element of market risk. It pertains to the changes in share prices due to overall market conditions. So, even if the company you've invested in is thriving, the stock price could still be negatively affected if the market undergoes a downturn. Therefore, market risk can still impact your portfolio, despite your investments being sound.

2. Credit risk

When you purchase a bond, you lend money to the issuer – be it a corporation or a government. In return for this loan, the issuer promises to make regular interest payments until the bond matures, upon which they return the principal. However, if the issuer experiences financial trouble and defaults on the bond, you may face credit risk resulting in a partial or total loss of your investment.

Various factors, including the issuer's financial stability, the overall economic climate, and the specific terms of the loan contract, can impact the degree of credit risk. 

For instance, a company with a strong track record of profitability and sound management would likely have a lower credit risk than a struggling company in a volatile industry. Similarly, a bond with a short maturity period might carry less credit risk than a long-term bond, because the issuer only needs to maintain its ability to repay over a shorter period.

It's also worth noting that the offered interest rate typically reflects the credit risk. Higher interest rates often correlate with higher credit risk, as the issuer must offer a higher return to entice investors to take on the risk of lending to them.

3. Liquidity risk

Liquidity risk arises when you are unable to sell an investment swiftly without incurring significant loss in value. These difficulties often crop up when the market suffers from limited liquidity. Consequently, you might have to part with your securities at a price much lower than its market value, leading to an undesired loss. 

Some investments, by their very nature, are harder to liquidate quickly. For example, assets such as real estate or private equity investments can be tricky to convert into cash speedily without incurring substantial losses in their value. Recognising this, investors generally anticipate higher returns on these illiquid investments. 

If you ever need to liquidate some investments in a hurry, a portfolio that encompasses both liquid and illiquid assets might provide a range of options without drastic shifts in the overall approach.

4. Inflation risk

Also known as purchasing power risk, inflation risk is the potential that the cash flow an investor receives from an investment will be worth less in the future due to inflation. With inflation, the value of money weakens over time, causing the same monetary amount to purchase less in terms of goods and services.

This is particularly relevant if you have cash investments or fixed-interest investments like bonds. For instance, if you invest in a bond with a fixed annual return of 2%, but inflation is running at 3%, the purchasing power of your money is effectively decreasing over time.

This means that investors, particularly those investing for long-term goals like retirement, need to consider investments that offer inflation protection. These may include certain types of stocks, real estate, or inflation-protected securities, which can potentially provide returns that outpace inflation.

That said, these types of investments also come with their own risks, such as market risk and liquidity risk. Therefore, it's crucial to balance the need for inflation protection with your personal risk tolerance and investment goals.

woman looking at her laptop in home

Now that you are familiar with the various investment risks, the next crucial step before you start investing is to assess your personal risk tolerance. This involves gauging how much potential loss you are willing to take in pursuit of potential gains.

Several factors can influence your risk tolerance, including your age, income, and financial goals. For instance, younger investors might be more willing to take on risk because they have more time to recover from potential losses. However, someone nearing retirement might prefer lower-risk investments to protect their nest egg.

By understanding your risk tolerance, you can craft an investment strategy that aligns with your comfort level and financial goals.

At this moment, you might be wondering when the perfect time to start investing in Singapore might be. Well, there's no universally "perfect" age or time to start investing. Instead, it depends on factors like:

1. Financial stability

Financial stability is essential before starting to invest. That means having a regular income, a well-stocked emergency fund, and manageable levels of debt. You don't want to put your livelihood on the line by investing money you can't afford to lose.

2. Risk tolerance

Your investment choices are largely shaped by your risk tolerance. If you're generally risk-averse, you may lean towards more conservative investment options. On the other hand, if you're open to higher risk, you might be drawn to investments with the potential for greater returns.

3. Investment goals

Investment goals also influence when you start investing. For long-term goals like retirement or buying a home in Singapore, beginning your investment journey earlier would be advantageous. This allows you to tap into the power of compound interest, where you earn interest on both your initial capital and the accumulated interest over time, which can significantly grow your wealth.

For shorter-term goals, you might prefer saving over investing.

That being said, investing is not just about when you start, but also how consistently you invest. The principle of regular, disciplined investing is a tried and tested foundation for long-term investment success. This approach is often referred to as dollar-cost averaging.

Dollar-cost averaging involves investing a fixed sum of money at regular intervals over an extended period. For example, you can allocate a set amount of money to an investment plan each month for the duration of 15 years. We’ve previously highlighted this as one of the seven things to think about before and while investing your money.

woman laughing while on laptop

With that, if you’re looking to start investing with $100 a month, you can consider Income’s AstraLink. AstraLink is an excellent choice for those who want to start with a smaller initial investment.

With a blend of investment and protection features, this Investment-linked Plan (ILP) offers an enticing Investment Bonus of up to 67.0% of your regular premiums paid in the 1st policy year, and up to 1.0% annual loyalty bonus from the 10th policy anniversary onwards.

AstraLink also allows for flexibility, allowing you to increase coverage at different life events1 with Guaranteed Insurability Option.

Or if you’re ready to dive in with a single premium investment from $5,0002, WealthLink can be a potential option. With WealthLink, you're granted the liberty to choose from a wide range of available funds3 and the flexibility to switch4 your funds, withdraw5, or surrender6 your investment at no charge. Moreover, you can top-up2 your investments to align with your financial strategy.

As you embark on your investing journey in Singapore, bear in mind that the journey may be full of surprises. But with a well-calculated strategy, persistence, and a good understanding of risk, your journey can be a rewarding one. To learn more, you can always reach out to an Income advisor for guidance.

Dayna is a skilled writer with a passion for sharing knowledge on a range of topics. From travel to health and wellness, Dayna’s articles are always informative and engaging, providing readers with valuable insights and actionable advice.

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