Investment Risk Pyramid: A Guide to Understanding Risk and Reward

Smart investing means understanding the investing risk pyramid!

• Too many people are investing speculatively just to make quick money. You need to learn some fundamentals to better understand the objectives of investing.
• The first consideration of investing is to secure returns. You should know the end goals of your investments, plus whether they are suited to the time frame of your goals or not.
• The second consideration of investing is to manage risk. You should know what level of risk you can stomach and how much of it you should take on. How much risk you take on may depend on whether you aim to grow your existing assets or protect them from inflation, with both in the context of your investment timeframe.

Investment Risk Pyramid

As you know, the risk-reward concept highlights the higher the risk of an asset, the higher the potential return. Whenever you invest your money, there is a chance that you could lose some or all of your money. How likely that varies from asset to asset, or even from different securities within an asset class (i.e. speculative shares are riskier than income shares).

The investment risk pyramid highlights the different levels of risk associated with different asset classes. The risk pyramid is not a scientific model and is only a rough guide!

High-risk investments: investing in this section comes with a warning – be prepared to lose a big chunk or even all of it! That said, this is possibly also where the highest volatility in your favour can occur! High-risk investments should not take up too large a percentage of your portfolio, especially if you are a conservative investor or are approaching retirement age.

Medium-risk investments: investments here tend to produce consistent returns over the long run, but short-term volatility remains possible. It is expected that these investments will benefit from capital appreciation. You should consider these investments reasonably safe.

Low-risk investments: the base of the pyramid. The investments here offer the lowest risk for investors, but unfortunately are likely to also offer the lowest returns. These types of investments are likely to make up the largest part of a more "conservative" (risk-averse) portfolio, but need not make up too much of a younger or more aggressive investor's portfolio.  

Ultimately, different people require different portfolios, so there is no set allocation you should follow based on this pyramid. However, the pyramid offers great use for helping identify which asset classes might be suitable for you, based on your risk-reward preference.

THE INVESTMENT RISK PYRAMID. COMPLETED. ✅

Sources:

1. https://www.sgx.com/research-education/market-updates/20181130-performance-highlights-spdrr-sti-etf-and-nikko-am-sti
2. https://www.fool.com/investing/how-to-invest/index-funds/average-return/
3. https://www.sgx.com/research-education/market-updates/20200102-sti-clocks-94-total-return-2019
4. https://public.com/learn/how-to-set-investment-objectives
5. https://www.oreilly.com/library/view/ft-guide-to/9781292129327/html/chapter-005.html
6. https://www.ocbc.com/simplyspoton/financial-wellness-index.html
7. https://www.investopedia.com/terms/b/buy-the-dips.asp#:~:text=%22Buy%20the%20dips%22%20is%20a,price%20in%20the%20short%2Dterm.&text=Therefore%2C%20they%20are%20buying%20when,some%20potential%20future%20price%20rise
8. https://www.fool.com/investing/how-to-invest/stocks/average-stock-market-return/
9. Header photo by Pexels