How much risk are you willing to take when you invest your cash?

Fsp Invest, 08 Aug. 2013

Tags: cash, invest, government bond, corporate bond, bond, equities, shares, risk,

When you invest your cash, you need to think about how ‘safe’ that money is going to be. You don’t want to put a lump of your retirement fund into high risk trading. Read on to find out how much risk your cash is taking on…

The lowest form of ‘investment’ is putting your cash into a bank account. This is the safest option you have, as John Stepek explains in MoneyWeek.

Next on the list is government bonds. These are relatively low risk too.

From these low risk asset classes, you need to take on more risk if you invest in corporate bonds and equities.

Let’s have a look at why…

Corporate bonds: Riskier than government bonds

Investing in corporate bonds – or investing in government debt from more exotic nations – is riskier.

Depending on how creditworthy the borrower is, you have to consider the chance that the borrower will go bust before they can pay you back.

The riskier the borrower, the bigger return you’ll want for your money.

That’s why the yield on Italian government bonds is higher than that on UK government bonds, for example.

And it’s why a big company like Tesco, issuing ‘investment-grade’ bonds, will be able to borrow at a far lower rate than a smaller, riskier firm, whose bonds might be classed as ‘junk’.

Corporate bonds are less risky than the equivalent shares in a company.

That’s because if a company goes bust, bondholders stand in front of shareholders in the queue for whatever is left.

Equities: You have a share in the growth, but can lose a lot too

When you buy an equity (or a ‘share’), you are literally buying part of a company.

It might not be big enough to give you much say in the running of the company, but it does make you an owner.

This means you are entitled to a share in the profits of the company.

So unlike a bondholder, who gets a fixed return, a shareholder in a growing company should share the benefits of that growth.

On the other hand, if the company gets into trouble, the shareholder has full exposure, whereas the bondholder has an element of protection.

Bottom line: The risks involved in being a shareholder are bigger than those of being a bondholder. And that’s why the potential returns are bigger too.

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