Investments come in many forms and may be classified in a variety of ways. One of the most common ways of subdividing categories of assets or investments is by risk.
Although an asset or investment can be classified as a “risk asset” if it bears any level of risk, the term is generally reserved for two specific types of assets.
First, it may describe investments whose values vary widely and often. Second, it may be used in reference to specific companies or investment opportunities that are distinctly identified as being high-risk for their type. For example, a bond issued by a company in financial distress with a higher-than-usual likelihood of bankruptcy and inability to repay the principle when it becomes due is an example of this second type of risk asset.
Risk assets are not necessarily undesirable or unattractive. Many risk assets have the potential to offer investors a significant return on investment. Understanding the types of risk assets available, their potential drawbacks and the possible rewards can help investors determine if risk assets are appropriate for them.
Risk assets are characterized by the potential for large gains and equally serious losses. Common examples include, but are not limited to:
The potential drawbacks of risk assets are fairly straightforward. Unlike an alternative such as Treasury bonds, which are nearly guaranteed to pay exactly what is promised when it is promised, risk assets always involve unpredictability. Investors have no assurances that their investments will increase in value, or that they will see results in any particular timeframe.
By adding risk assets to their portfolios, investors accept that they may lose some or all of the funds they invested in those assets. They also, therefore, accept that they may need to reinvest new funds in future specifically to balance those losses or make significant adjustments to their investment strategies.
At first glance, the benefits of risk assets can be far less readily visible than the drawbacks. What risk assets cannot offer in stability and predictability, however, they make up for in their potential for aggressive returns on investment. By strategically integrating risk assets into their portfolios, investors can:
Risk assets are essential for investors who need or want to build wealth quickly. Low-risk assets such as Treasury bonds or simply do not offer the rate of return that investors need to multiply their investments over the short term. There are many reasons why investors might seek to maximize short-term gains.
For example, investors approaching retirement may find that earlier investment strategies have left them with a gap between their desired retirement account total and their actual holdings. An aggressive short-term investment policy with an emphasis on carefully selected risk assets may allow them to close that gap. New investors seeking to jump-start a lifetime of investing with only a small initial investment may strategically use risk assets to double or triple their start-up funds. This can allow them to diversify quickly and build stability in their portfolios long before they would otherwise be able to do so.
Investors can also use risk assets as part of a larger plan to realistically achieve long-term goals. Investors who generally prefer less volatile investment tools may find that, even over time, those other tools alone are not sufficient to build their total wealth to target levels.
In those cases, such investors face three choices. They can reduce their target goals, they can earn and invest larger sums of money in their preferred “safe” investment tools or they can use higher-yielding risk assets to make up the difference. Reducing target financial goals can result in the loss of personal comfort, security and opportunity. Earning enough money to adequately invest in “safer” financial tools may be impractical or carry severe consequences for the investor’s health and lifestyle. Incorporating a modest number of risk assets into their portfolios allows investors to reach their goals with a minimum of life disruption or personal loss.
Finally, investors can use risk investments to adequately balance and diversify their investments. Different types of assets are subject to influence, valuation and devaluation from a variety of forces. Investor confidence, interest rates and other prime influences can have distinct or even opposite effects on different types of investments. Investors can use this knowledge to their advantage. For example, an investor might identify the social or economic circumstances most likely to drive down the value of their primary investment tools. They could then intentionally select risk assets that have historically gained value during those same circumstance to balance their portfolios. This would allow them to offset the risk of losses in a worst-case scenario.
Regardless of their approaches, most investors will find that risk assets offer enough powerful benefits to earn a place in any investment strategy.