Risky Investments Do Not Always Offer the Biggest Returns

Some people believe that the riskier an investment is, the higher the potential for returns. This is not always true or all of us would hope to get rich by winning the lottery. Financial planners explain that rewards increase with the risk you are willing to take. What they should explain, however, is that there is a point in which returns diminish with risk taking.

In fact, investments which are very risky, like emerging market funds and gold funds, may bring you catastrophic losses. Emerging market investments involve investing money in development projects and corporations which operate in foreign states. Usually, these are located in less developed countries which seek to attract foreign investment. To attract cash from developed postindustrial countries, such emerging markets promise better returns from volatile growth rates, with growth rates being higher than in developed countries. In fact, growth rates may be close to twice as high in developing states.

The bad news is that the longer investors hold an emerging market investment, the higher the risk of losses. With volatile funds as these, it is always wise to develop an exit strategy. You may not get any rewards with many volatile funds, or they may not be worth the risk. Imagine that you invest $5,000 in a fictitious volatile fund, which is the growth fund type. It has gained 50 percent a year over the first two years and then lost 50 percent. The first year, your money increases to $7,500 and the second year to $11.250. This is impressive, isn’t it? Now consider the losses. If the fund loses 50 percent during the third year, what you are left with is $5,625. In three years, you will have earned $625, which isn’t very impressive. This is the main problem of volatile funds. While they promise investors outsized gains, the latter are often matched with huge and even catastrophic losses. The longer investors hold their investment, the bigger the chances this will happen.

Taking these into consideration, what types of investments carry risk and what risk do you face by investing in them? One option is to invest in the stock market, and it is you to determine the amount of returns you want. You can invest in equities and stocks that have the potential to bring these returns. Of course, there is no guarantee you will profit from your investment, and you may even lose a portion or all of your money.

Forex trading is another option for high-risk investors. Here, you will be trading different currencies, and the risk you face is explained with the fact that the value of one currency can change in seconds against the value of another currency. The value of a currency may change with different factors affecting it – e.g. global and current news, trading relationships between countries, and so on.

Real estate speculation has become popular over the last couple of years. Speculators seek to buy property or land low and sell it at a profit. While this type of investment sounds attractive, with returns of 100 percent in some cases, it is very risky. Here, the idea is to purchase a home or property below market value from a home owner with financial troubles or at a foreclosure auction. Then, the speculator sells the property within few months to yield high returns.

If you are on the other extreme, you may be looking for low-risk investments, i.e. investments that are safe from the point of investment risk, be it economic risk, inflation risk, liquidity risk, etc. One such option is mutual funds. Investing in this type of investment instrument is regarded as a good way to beat inflation. Here, your money will be invested in an equity market and managed by professionals with experience on the stock market. There are plenty of mutual funds on the market, so it pays to check the amount of returns of various funds over a certain period of time.