A lot of investment advice centers on producing as much return as possible for as little risk as possible. But what about the other side of the coin? What about embracing the possibilities of risk and actively seeking to build a high-risk investment portfolio? Such a portfolio could hold considerable promise for market-beating returns, but investors need to mindful when approaching this type of investment.
Why Seek Risk?
The linkage between risk and reward is not always perfect or predictable, but there is a time-tested correlation between risk and reward. If investors want higher returns, they have to be willing to take on higher risk. Said differently, though, if an investor can accept higher risk, he or she can also potentially realize considerably higher returns.
At NEBA Financial Solutions, we can customize a Structured Product based on your attitude towards risk. You can have the most adventurous basket you can think of but this is usually accompanied by a very high volatility product. On the other end of the spectrum is by choosing low volatile underlyings to give a much safer investment.
For example, taking four of the most volatile underlyings and taking four of the least volatile underlyings, we get to see how much different it makes to pricing.
Based on our findings as placed into the table below, we see a distinct correlation between the volatility and the return.
In this case, investors of various risk appetites get to select which investment is more suitable for their portfolio. Some may prefer the lower risk option at 6.57% p.a. while others may perceive the *37.03% p.a. to be aligned with their interests and worth the risk-taking.
Not All Risk Is the Same
One of the most important concepts in building a high-risk portfolio is that not all risk is the same. A close corollary is that investors should only seek out the smart risks, the risks they get compensated for taking. For instance, investing in the equity of bankrupt companies almost never pays off. Yes, the stocks trade for pennies and the companies often survive, but the bankruptcy process almost always completely wipes out equity investors and there is not enough wiggle room in that “almost” to validate the risk.
Investors should also guard against laziness and complacency. High-risk investing demands responsiveness and attention to detail. So while building a portfolio without thorough due diligence and then ignoring it is certainly high-risk investing, it is not a kind of risk that will earn extra rewards.
Risk-seeking investors also need to be smart about leverage. It’s all well and good to use leverage to ramp up the return potential of a portfolio, but investors should be careful to limit their maximum losses to a level they can afford.
Investors with the financial capacity to take on risk should not shy away from it. Over time, intelligent and disciplined risk-seeking behavior can produce substantially above-average returns. The key, though, is “intelligent” and “disciplined”; investors must seek out the risks that can earn them better returns and strictly avoid (or minimize) those risks that do not add any money to their pocket.
*NEBA does not generally recommend such high-risk investments unless otherwise sought by a professional.
Visit www.nebafinancialsolutions.com to see our Structured Products and UCITS Funds http://www.nebafinancialsolutions.com/Risk-Rated-Portfolio-DFM, http://www.nebafinancialsolutions.com/real-asset-fund