We have all heard this statement many many times. This statement is applicable to many different situations including our financial situations. All the recommended investment practices are based on this statement.

To understand how this statement is applicable to investments lets start at the beginning - by defining ‘investment risk’.

Every investment comes with a certain amount of risk. Risk can be defined as the chances of losing your investment or the chances of the return of an investment being lower than the expected return. The uncertainty factor associated with every investment is the investment risk associated with that investment. Usually if an investment has a higher risk then the returns expected are also higher. There is no point investing in a risky investment if the returns are low.

The amount of risk a person is willing to take is called the risk tolerance of that person. The risk tolerance varies from person to person.

There are different types of risks associated with every investment. A big part of the risk can be reduced by diversification. Diversification is the process of investing your money in different asset classes.

Every asset class moves in different investment cycles. If you invest only in one asset class then there is a risk associated with ups and downs of that asset cycle and your investment is prone to that risk. If you diversify and put your investment in different asset classes then you reduce that risk. If one asset class is moving down then an other asset class will be up thus reducing the overall downturn in your investments (in the process reducing your overall investment risk). Of course there are certain factors which can affect the returns of more than one asset class (like a recession in the economy).

There are four main asset classes:

• Cash based investments (example savings accounts)
• Fixed interest investments
• Property
• Shares

Cash based investments and Fixed interest investments have the least amount of risk. And hence they also have the lowest amount of returns. Shares have the highest amount of risk and hence also give you the highest amount of returns. A good portfolio is one that has money spread across each of these asset classes. How much money you have to put in each of these asset classes depends on your risk tolerance.

The type of portfolio you decide to have depends on two main factors:

• Your risk tolerance
• The period of investment (you might have one investment strategy for your retirement portfolio, if you have 25 years to retirement and another for the portfolio you have created for saving up for your kids education). Normally the longer the time frame the more risk an investor will be willing to take.You will have to invest in assets classes with higher amount of risk for longer periods of time to weather out the risk involved and get the maximum benefit of the high returns of that asset class.

There are three main types of investors:

• Conservative - These have minimum risk tolerance and hence most of their investments will either be in cash or fixed interests.
• Moderate - Their risk tolerance is higher than a conservative investor. They tend to invest more in shares and property.
• Aggressive - These investors have very high risk tolerance. They invest a large portion of their investments in shares.

So figure out where you stand and start making the right investment decisions….

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