The rewards of risk – how to help your clients understand investments

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The rewards of risk – how to help your clients understand investments

Many clients want to invest, but when it gets right down to it they may not be comfortable with the idea of risking their money.

The truth is, risk and investing go hand-in-hand. But that doesn’t mean investing has to be excessively risky.

Here’s how to explain risk, reward, and risk management strategies to your clients.

What’s at risk?

First off, investors need to understand that all investments carry risk. But what exactly do we mean when we talk about risk?

Risk is the possibility that an investor will lose some or all of their original investment, or that an investment won’t achieve its projected gain.

Risk is not the same as volatility. Many investments experience short-term fluctuations in value for a variety of reasons, including internal corporate causes, inflation and external market forces, which may result in short-term losses. But an investment’s volatility isn’t necessarily an indicator of how risky it is.

The risk-reward relationship

Generally speaking, the higher the risk, the greater the potential reward. Offering a high return is how companies engaged in risky endeavours are able to convince investors to back them. Biotechnology companies, for example, have a very high failure rate in developing new drugs. But a successful new drug can send stock prices soaring.

Safer investments — those with low risk that virtually guarantee that principal will be preserved, such as Treasury bills, government bonds and GICs — usually earn very low returns.

Clients who sit on the sidelines and park their money in cash may think they’re choosing the zero-risk option. But inflation slowly erodes the buying power of cash (and low-return investments), which means that 5, 10 or 20 years from now, those funds will no longer be able to purchase the same amount of goods and services they can buy today.

The effect on someone saving for retirement could be devastating.

Managing risk

There are much better ways to manage risk and its effects, and it’s important that your clients understand how you do this:

  • By carefully researching investments and discussing with them the potential risks and rewards of each investment or the portfolio as a whole.
  • By working with clients to understand their expectations and risk tolerance, so you can select the investments that will perform best for their needs.
  • By considering each client’s investment horizon so you can recommend a portfolio that should show positive returns within the target time frame.
  • By diversifying the portfolio across asset classes (for example, by shifting the balance of stocks and bonds) to help mitigate losses, depending on that client’s risk tolerance and investment horizon.

Easing the worry

Some investors get scared because they imagine scenarios in which they will lose a major chunk of their savings. But realistically, a carefully structured and well-managed portfolio includes checks and balances to optimize the potential upside while reducing the potential downside.

Remind your clients that your role is to work with them to develop an investment strategy that meets their investment needs while managing risk.

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