Every investment involves a tradeoff between risk and return. Higher potential returns generally come with higher risk — meaning more short-term volatility and a greater chance of losing money over the short term. Understanding this tradeoff is the foundation of making good investment decisions.
What Is Investment Risk?
In investing, risk does not simply mean “the chance you lose everything.” It is more nuanced:
- Volatility risk — how much an investment’s price fluctuates over time
- Liquidity risk — how easily you can convert an investment to cash when needed
- Credit risk — the chance a bond issuer or bank defaults
- Inflation risk — the chance your returns do not keep up with inflation
- Concentration risk — too much exposure to a single asset, sector, or country
- Sequencing risk — receiving poor returns early in retirement when you are drawing down
For most beginner investors, the most visible form of risk is volatility — seeing your portfolio fall 20% in value and wondering whether to sell.
The Risk-Return Spectrum
Different asset classes sit at different points on the risk-return spectrum:
| Asset class | Typical annual return range (historical) | Typical max short-term drawdown |
|---|---|---|
| Cash (savings) | 2–5% | Near zero |
| Term deposits | 3–5% | Near zero |
| Australian bonds | 3–6% | -5% to -15% |
| Australian shares (ASX 200) | 7–10% (total return) | -50% (GFC 2008–09) |
| International shares | 7–10% (total return, unhedged) | -50%+ (GFC) |
| Australian residential property | 6–8% | -10% to -25% |
Historical returns are not a reliable indicator of future returns. Returns will vary significantly in any given year.
Time Horizon Is the Key to Managing Risk
The most important factor in managing risk is time horizon — how long until you need the money.
Over a short time horizon (1–3 years), a 30% market crash can permanently damage your financial position if you are forced to sell at the bottom. Over a long time horizon (10–20+ years), the same 30% crash is a temporary dip in a long-term upward trend.
Historical context:
- The ASX 200 fell approximately 55% during the 2008–09 GFC, then recovered to pre-GFC levels by early 2013
- The ASX fell approximately 35% during the COVID crash of February–March 2020, then recovered to pre-COVID levels within 9 months
Long-term investors who stayed invested through both crashes saw their portfolios recover and grow. Investors who sold at the bottom locked in losses permanently.
Understanding Your Risk Tolerance
Risk tolerance is a combination of two things:
- Financial capacity — how much loss you can actually afford (based on time horizon, income, debts)
- Emotional tolerance — how much volatility you can handle without making poor decisions (like panic selling)
Questions to ask yourself:
- If my portfolio dropped 30% in value next month, what would I do?
- How many years until I need to draw on these funds?
- Do I have an emergency fund separate from my investments?
- Do I have other stable income (e.g., super, rental income, salary) to rely on?
If a 30% drop would cause you to sell everything, a more conservative asset allocation may suit your emotional tolerance better — even if you could technically afford more risk based on your time horizon.
Common Risk-Rated Portfolio Profiles
| Portfolio type | Shares allocation | Bonds/cash allocation | Suited to |
|---|---|---|---|
| Defensive | 20–30% | 70–80% | 1–3 year horizon, or low risk tolerance |
| Conservative | 30–40% | 60–70% | 3–5 year horizon |
| Balanced | 50–60% | 40–50% | 5–7 year horizon |
| Growth | 70–80% | 20–30% | 7–10 year horizon |
| High growth | 85–100% | 0–15% | 10+ year horizon, high risk tolerance |
Risk and Diversification
Diversification does not eliminate risk, but it reduces concentration risk — the chance that any single investment’s failure destroys your portfolio. A well-diversified portfolio spreads risk across:
- Many companies (via ETFs holding hundreds or thousands of stocks)
- Many countries (Australian and international exposure)
- Multiple asset classes (shares, bonds, property, cash)
What Risk Is Not Worth Taking
Some risks are poorly rewarded — meaning you take on more risk without receiving proportionally more expected return:
- Holding individual stocks without diversification (company-specific risk is uncompensated)
- Using leverage (borrowing to invest) to buy volatile assets — amplifies both gains and losses
- Cryptocurrency at high portfolio weightings — extreme volatility, immature asset class
- Speculative “hot tips” or unlisted schemes — information asymmetry almost always favours the seller
Related Articles
- Investing for Beginners Australia
- Asset Allocation by Age
- Growth vs Defensive Assets
- Diversification Explained
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- Investing hub
Frequently Asked Questions
Is investing in shares safe in Australia? Australian shares are ASIC-regulated and held in your name on the CHESS system (or via a CHESS-sponsored broker). The risk with shares is not that the ASX collapses — it is that individual companies can fail, and the market as a whole can fall significantly in the short term. Broad ETFs that hold hundreds of companies significantly reduce company-specific risk, but market risk remains.
What is the safest investment in Australia? The safest investments are APRA-regulated bank deposits (protected up to $250,000 per person per institution under the Financial Claims Scheme) and Australian Government Bonds. These are very low risk but also offer lower potential long-term returns than growth assets like shares.
How do I know how much risk to take? Your appropriate risk level depends on your time horizon, financial situation, and how you’d respond to significant portfolio losses. Many super funds and financial planners use risk questionnaires to help determine this. Speaking with a licensed financial adviser can be valuable if you’re uncertain.
This article provides general financial information only. For advice tailored to your situation, speak with a licensed financial adviser. You can find one through the ASIC financial advisers register or MoneySmart.