Risk and return: the main types of assets

Every investment is a trade-off between how much it might grow and how much it might fall. Knowing the main asset types helps you see through hype and ask the right questions.

The basic trade-off

• The FCA's rule of thumb: 'the higher an investment's potential return, the higher the risk of losing your money.'
• The FCA also says every investment carries some degree of risk, some much more than others.
• Investor.gov defines risk tolerance as your ability and willingness to lose some or all of your original investment in exchange for potentially greater returns.
• Time horizon matters: Investor.gov notes that people investing for longer may feel comfortable with more volatile investments, while those with shorter horizons usually lean towards steadier ones.
• Anything promising high returns with no risk is a warning sign, not a bargain.

Cash and savings

• Cash in a bank savings account is the most stable option: the number in your account does not fall.
• Its main risk is inflation: if the rate paid is below inflation, your spending power falls slowly, as covered in the previous lesson.
• Cash is the right home for emergency money and short-term goals.

Bonds and sukuk

• Investor.gov describes a bond as a debt security: you lend money to a government, municipality or company, which pays a set rate of interest and repays the face value at maturity.
• Bond risks include default (the issuer cannot pay), interest rate risk (the bond may be worth less if you sell early after rates rise) and inflation risk.
• Bonds are often held alongside more volatile shares to balance a portfolio, but they are not risk-free.
• Sukuk are Shariah-compliant certificates linked to underlying assets rather than interest-bearing loans; they are covered in the Shariah lesson.

Shares (stocks or equities)

• Investor.gov explains that a share gives you part ownership of a company.
• You can gain if the price rises above what you paid, and some companies pay part of their profits as dividends.
• Share prices go down as well as up, and Investor.gov warns that you can lose money you invest in stocks.
• If a company goes bankrupt, bondholders are paid before shareholders, and ordinary shareholders may get nothing.

Property, gold and funds

• Property means buildings and land. It can provide rent and may rise in value, but it usually needs large sums and can take a long time to sell. Some funds invest in property, according to the FCA.
• Gold and other precious metals: the US Commodity Futures Trading Commission (CFTC) calls them 'highly volatile' and says past performance is not a good predictor of future returns.
• The CFTC also warns that when you buy gold coins or bars you pay a dealer markup (premium) above the market price, so the price must rise enough just to cover your costs.
• Funds pool money from many investors into one pot that buys many investments, the FCA explains, which makes spreading risk possible even with small sums.
• A fund is only as risky as what it holds: a fund of one country's shares behaves very differently from a fund of government bonds.