INTRODUCTION TO PERSONAL INVESTING PART 3 - THE BASICS OF RISKS AND RETURNS

Many Singaporeans know the importance of growing their wealth, but do not know where to start. In the last of a 3-part series on Personal Investing, we explain the concept of return and risk. These tips are taken from the 'Introduction to Personal Investing' handbook produced by the Investment Management Association of Singapore (IMAS) under the MoneySENSE national financial education programme. 

The concept of return and risk are primary considerations in investing. They are likely to form the basis for almost all your investment decisions. 

Return - What Is It?

Your investment return is simply what you gain (a positive return) or lose (a negative return) on your investment after you have sold it. Even if you decide not to sell your investment, you can still calculate your return by comparing the investment's market value against your purchase price.

The return from an investment usually consists of two parts:

(i) An interest or dividend payment in cash - also called 'income'. When the income is expressed as a percentage of the purchase price, it is known as the 'yield'.

(ii) The rise (or fall) of the value of the investment - called 'capital gain (or capital loss)'.

You can use annualised returns to compare returns between investments held over different holding periods. For example, if you had an investment that gave a return of 30% over 3 years, your annualised return would be 9.1%.

Remember you will have to account for transaction costs and charges when computing returns, as these will eat into your returns. For example, you will incur brokerage charges when you buy or sell shares. When investing unit trusts, you will also have to bear management fees and other expenses.

Risk - What Is It?

There are two types of risks:

· Systematic risk - these affect the market in general, e.g. economic conditions, changes in interest rates, changes in market sentiment or Government policies.  As an investor, you cannot avoid systemic risks.

· Non-systematic risk / specific risk - these are factors that apply only to the investment you hold, e.g. quality of a company's management, sustainability of its products and services.  This can be reduced by spreading your risks over a number of holdings.

The Risk-Return Trade-Off

Investments that offer higher expected returns are also likely to have higher risks.  There is 'no free lunch' in investing.  A common mistake that investors make is to focus only on the expected return of the investment.  Ask yourself:

(1) What is your tolerance for risk?  This will depend on factors such as your cash flow situation, financial position, future commitments and number of dependents.

(2) What is your investment time horizon?  In general, the longer the time you have to invest, the more risk you can take on.

Diversification - A Tool To Manage Risk

Diversification means spreading your investments over a variety of assets to avoid too much exposure to a single source of risk. 

You may sometimes find that you do not have enough resources to diversify your portfolio or you do not have the expertise to choose different investments in different sectors.  Consult a professional if you are unsure about your investments.

"These articles were provided by the Monetary Authority of Singapore and the Investment Management Association of Singapore (IMAS) as part of the MoneySENSE national financial education programme. For more information on personal investments, please refer to the MoneySENSE website at www.moneysense.gov.sg or IMAS' website at www.imas.org.sg".