“How much money am I prepared to lose?” is a question every investor should ask before investing. Why? Because the decision to invest involves taking risks and different investment products come with varying degrees of risks. Investment risk is the possibility of losing some or all of the money that you have invested. The rule of thumb is simple – the higher the potential reward offered by an investment product, the higher its investment risk will be. Conversely, if the risk of an investment product is low, its reward will also be low.

“But can I avoid investment risks altogether and ensure that my money is safe and earning consistent returns?” The simple answer is NO because no matter what you do with your money, it will still be exposed to some form of risk. You can put your money under the mattress but you risk losing all of it if there is a fire or theft. If you put your money in the bank, the interest rate may not be high enough to match the inflation rate and thus, leaving you with less buying power in the future. And if you put your money in an investment product, you will face various investment risks associated with the product.

Managing your risks

As an investor, you cannot eliminate risks altogether. However, investment risks are not all that bad and you need to manage them to make them work for you. The first step is to determine how much risk you are prepared to take. Making investment decisions based on what your friends or relatives have invested in is not a good way to manage your risk. This is because different individuals are prepared to take different levels of risks. Some people are prepared to lose more money than you. To know how much risk you can handle, here is a simple rule: If you’re unable to sleep after buying an investment product, then it is probably too risky for you.

Another way to manage risk is to avoid putting all your eggs in one basket. You should not invest all your money in just one investment product. If you put all your money in one type of investment, you can lose all your money if the value of the investment falls. To minimise investment risks, it is best to invest in a few investment products, for example, in a mix of shares, fixed deposits, unit trust funds and properties. This is known as “diversification”.

Diversification involves mixing high-risk investments with low-risk ones, so that losses in non-performing investments will be offset by gains in better-performing ones. This helps you to minimise investment risks and at the same time, maximise your average return on investment.

However, it is also not advisable to over-diversify, as spreading your money too thin can depress the potential returns of your investments. While you don't want to put all your eggs in one basket, you don't want to put them in too many baskets either!

Determine your risk tolerance

Different folks have different strokes. Some investors can cope with high investment risks, while others can’t. A person’s risk tolerance may change according to his stage in life. An individual, who is willing to take high investment risks when he is still young and single, may be less willing to take the same risks when he is older and has a family. To determine your risk tolerance, you need to ask yourself these simple questions:

If your answers are mostly As, investments that come with high risks are most probably not suitable for you. You will be better off investing in products that give you reasonable and consistent returns and at the same time, preserve your initial capital.

If your answers are mostly Bs, you are most probably able to cope with investments that come with high risks. However, the ability to handle risks alone is insufficient. In addition, you also need to consistently enhance your investment knowledge and monitor your investments. Avoid falling into the trap of trying to make a fast buck without knowing what you are getting yourself into!