It’s the age-old question seasoned investors are often asked: is investing risky?

Often, the answer differs according to the views and experience of each investor. Those who have lost money in major financial crises might say yes, it is definitely risky and tantamount to gambling.

Others would say it depends on your level of skill and expertise, and how much due diligence you carry out prior to making any investment decisions.

The truth is, it all depends on what your definition of the word “risk” is. Here are four broad perspectives that can help you form your own conclusion.

1. Short-term volatility

Fixed deposits are low-risk, while stocks and cryptocurrency are considered high-risk investments – the rationale being that the levels of risk are based on the volatility of asset prices in the short-term.

If you place RM100,000 into an FD account, you can expect the amount to generate interest within a stipulated time frame. But the same cannot be said with certainty when it comes to stocks and cryptocurrency. The degree of fluctuation in the value of Bitcoin, for example, is huge as its price could rise or fall in great increments – making it “higher-risk”.

So, is short-term volatility a good way to measure investment risk? If you wish to build an emergency or reserve fund, then yes, you would be better off utilising financial assets such as FDs, Amanah Saham Bumiputera funds, flexi-loan accounts and, more recently, digital cash-management platforms such as KDI Save.

Therefore, the view that “stocks are high-risk and cash is low-risk” is true if your goals are simply to build reserve funds or generate dividends in a short period, as opposed to building wealth in the long run.

2. Pledge of securities

Why does a bank charge low interest rates for its mortgages and higher interest rates for its credit-card lending? This is likely because a mortgage is linked to a tangible property and is, thus, securitised and deemed “lower-risk”.

Credit-card debt is unsecured, so banks impose higher rates to compensate for the perceived higher risk associated with these liabilities.

In this sense, investment risk is measured based on the recoverability of capital, which can be assessed by the valuation of assets pledged. The more valuable the assets, the lower the risk of an investment.

Savvy investors would want to know and assess the underlying assets of each investment before making any commitments. For instance, if you’re looking to buy stocks, you would first study the company’s business model to ensure it has real assets, real customers, and a genuine ability to earn consistent profit in the long run.

3. Credit assessment

How does a bank reduce its non-performing loans when lending? By first assessing the creditworthiness of a potential borrower, which includes learning about his or her income level and repayment behaviour.

Without credit assessment, lending is very risky. Likewise with investing – although this is only true if one fails to do any sort of credit assessment on stocks before buying.

It’s possible for stocks to be “safe” investments if one is diligent with carrying out studies on a company’s business models, financials, and current initiatives, to ensure future sustainable earnings growth.

By doing this, investors can reduce or eliminate non-performing investments, similar to how a bank reduces its non-performing loans.

4. Education and experience

In a way, investing can be likened to driving a car. You would know when to slow down or speed up, when to stop, how to read road signs and interpret the colours of traffic lights, and so on. Experience and confidence is developed over time through practice, starting from short drives within neighbourhoods to long-distance travel.

Similarly, an educated and experienced investor is one who knows how to differentiate between good and bad stocks. In the stock market, it is common to find people who want to “drive” but do not know how, which causes them to “crash” as they are unable to navigate market conditions.

In short, the more education and positive experiences an investor has amassed, the lower the investment risk.

Conclusion

It’s possible for risks to be lowered progressively as investors grow and mature in their capabilities over time. This would involve:

• adopting a learning attitude about investment;
• focusing on building skills and experience;
• finding a system of assessing credit effectively;
• developing a habit of learning about the underlying assets of any investment; and
• not investing with funds that are meant for emergencies.

This article first appeared in KCLau.com. Ian Tai is a financial content writer, dividend investor, and author of many articles on finance featured on KCLau.com in Malaysia, and ‘Fifth Person’, ‘Value Invest Asia’ and ‘Small Cap Asia’ in Singapore.