Investment and Risk

 

The purpose of an investment is generally to get returns in the form of interest and/or an increase in the value of the money. But securities trading always involves risk, in the worst case, your invested money may disappear.

 

By Viktor, co-founder of Bifrost - Jan 14 2019

Investment and Risk

Interest rates are often associated with investments in interest-bearing investments, such as bonds and bank accounts. Value increase is usually used in connection with shares or equity-related assets and means that the price of the asset increases during the time you hold it. You must not forget that the price of the asset can also fall and that you, in that case, do not get back the money you invested.

Risk and risk diversification

In connection with an investment, there is the risk that you will not get back the entire capital and partly that return will not be the one you thought. The risk that you will not get back invested capital may, for example, be that the borrower goes bankrupt or that you have invested in an asset that falls in value, for example, listed shares. The risk that you will not get the return you wanted is higher if you invested in shares than if you placed your money in interest-bearing investments like bonds. Shares and assets based on shares normally involve significantly higher risk. You can lose some of, or even the whole, of your invested capital. On the other hand, there is an opportunity for higher returns compared with interest-bearing investments. The return on interest-bearing assets is often an agreed interest rate.

Spreading risk

You can reduce your overall risk by spreading your risks - "Don't put all your eggs in the same basket". By dividing your total investment into different investments, you do not expose the entire investment to the same type of risk. If you have your entire savings invested in shares in a single company, your return is entirely dependent on the return on those shares. If you instead place your savings in several companies' shares (or in a mutual fund), your total risk decreases.

This reasoning is for example used in Modern portfolio theory (MPT) by Markowitz, the Nobel prize winner. If you place your investment not only in shares but also in interest-bearing investments, your risk is further reduced. At the same time, you have also reduced your opportunities to get a high return.

Borrowing against securities

It is not uncommon to borrow securities, that is, borrow money from a lender with securities as collateral. If you choose to buy securities with borrowed money, you must be aware that you increase your risk-taking considerably. This is usually called securities-based-lending (SBL). SBL can in the right situation be a win-win for the borrower and lender, but the growing usage has led to concern to what could happen if the market turns. This is because, if your investment fails, the consequences will be much worse than if you had not borrowed money.

Liquidity

When making investments you should ask yourself how long you can spend the money. Even if you have not planned that the money will be used on an occasion, it is important to know how liquid the investment is, that is, how quickly you can sell. You may end up in a situation where you suddenly need money.

You need to make this assessment for every investment you make. If you buy a house, it normally takes quite a long time to get it sold and get the money in your hand. If you invest in one of the most traded shares on FTSE 100, you can probably get them sold within minutes.

It is important to remember that there are no guarantees that a deal may be made. There may be technical problems - computers may be acting up and telephone lines can be overloaded. It can also simply be that there is no one who wants to buy what you want to sell.