Risk VS Return

With low returns from government bonds and cash, we re-examine the debate of risk vs reward.

Article updated: 25 January 2021 12:00pm Author: Ian Forrest

The age-old balance of risk versus return has come to the fore again recently as investors observe the dismally low returns available from government bonds and cash holdings. With interest rates unlikely to rise any time soon and central banks very conscious of the risks of allowing bond yields to rise given the high level of corporate debt which now exists, those assets look less and less tempting to many investors.

Clearly that is especially true of investors who rely on achieving some income from their investments and are all too aware that some stalwart dividend payers have cut back their dividends, they prefer the term “re-based”, in recent times.

Some investors look at the 3.5% yield offered by the FTSE 100 and the even better 5%+ available in certain sectors, such as oil and gas and utilities, and see those stocks as attractive options. But is that really the case?

Its important for investors to look at the whole story and not place too much focus on returns from investments without also properly considering the level of risk they’re taking in order to get those returns. Successful investing relies on navigating the line between risk and return. For every investor that line is in a slightly different place because every investor has their own sense of what level of risk they are comfortable with and what minimum level of return they require in exchange.

Sometimes it can feel as if you need two sets of eyes to be able to keep track of both as they fluctuate over time. That is especially true if you invest mainly in individual stocks rather than funds. The big institutional investors are highly vigilant and can afford to have teams monitoring their holdings every day, regular analysis and complex valuation modelling.

For most personal investors that’s not a realistic approach. Instead, its more practical to review holdings every three months and try to ensure that there is a good spread of diversity across different regions, sectors and asset types. Along side that investors need to get a sense of whether their portfolio has an overall risk level that they are comfortable with and whether it is achieving the sort of return, over the long term, which they are seeking.

To help with that investors will find our Investment Research Policy useful as it gives more detail on the risk categories we use for the funds on our preferred lists, including unit trusts, ETFs and investment trusts. They range from the lowest category of L1 up to the highest of H10. The policy can also be found at the bottom of our fund pages.

As I mentioned earlier there are times in the market cycle when shares can look appealing relative to other investments, but when that is the case it is vitally important that investors always maintain an eye on the level of risk they are taking overall. The reason goes back to what I said about high levels of corporate debt and great economic uncertainty. Many companies have been weakened by the Covid pandemic and its various lockdowns, including many in the travel and leisure and retailing sectors. Recent data shows that companies around the world issued a record amount of debt securities last year, around $5.4 trillion, which will have to be serviced through interest payments. While there are reasons to be optimistic in the longer term the legacy of the pandemic is likely to persist for some time yet.

All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.

Ian Forrest portrait photo
Ian Forrest

Investment Research Analyst

Ian’s background in investments, financial journalism and research has seen him advising private investors on equities and helping to manage portfolios. His qualifications include the Certificate in Financial Planning and the Chartered Institute for Securities & Investment’s Investment Advice Diploma.

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