Understanding High Risk Investments

With high risk investments, there’s really no guarantee on your capital and investments can be really volatile. But it too has its benefits.

Let’s say two people, Stella and Titi, enter into an investment with the same amount of ₦100,000. Stella is risk averse, and chose to enter into an investment that guaranteed her capital sum of ₦100,000 and only provided an annual interest rate of 10%.

On the other hand, Titi believes she can invest her way to financial breakthrough if only she chose the right kinds of investments. She finds a speculative investment that promises her 40% per annum.

Assuming both of them reinvest thus allowing their investments to compound, here’s how both of them will have fared:

After year one, Stella’s investment will have grown to ₦110,000 and after year two, she will have ₦121,000 in her books. Titi on the other hand will have a whopping ₦140,000 in year one and by year 2, her investment will have grown to ₦196,000.

With Stella’s investment, because it has zero risk (like treasury bills), we can predict her entire profit going 10 years. However, Titi’s risky investment cannot be predicted. If in year 2, the company loses out on a deal and can only return half of her investment total to her, then she will have only ₦98,000.

But, if everything goes well up until year 10 before the investment has issues, even if she loses 50% of her year 10 investment which will have grown to ₦2,892,547, she will still have ₦1,446,274 left.

In 10 years, Stella’s investment with no risk will still be ₦259,374. Titi’s investment will have to lose as much as 90% for it to perform as low as Stella’s steady growing investment.

Investment risk is a key area every investor must be wary of before venturing into any investment project. This is because the state of your entire investment is subject to how much risk you have taken on as well as its corresponding probability of loss.

With risk, there is a trade-off. The lower the risk, the lower your expected gain and the higher the risk, the higher the potential gain. A high-risk investment is any investment in which there is a high possibility of a loss of capital or under-performance.

With high risk investments, there’s really no guarantee on your capital and investments can be really volatile. But it too has its benefits.

For one, they can yield larger than normal gains. However, all of this loss is restricted to the amount you invested initially. In other words, even if Titi lost all her money, she doesn’t lose more than the ₦100,000 she invested (it could be more with certain investments.)

The disadvantages of high risk investments also go beyond the risks. For one, you have no control of how anything turns out. Also, with some stock investments, you will be the last to be paid after preference shareholders who had taken on little risk have been paid.

For every investment you take, it is important to evaluate the risk factor based on your risk threshold and manage your expectations accordingly.

Written by Lawretta Egba.