You must have come across risk-free assets. The risk-free term implies that the assets you are investing money in are completely risk-free. The fact is that these things seem good to read in theoretical books. Practical life is completely the opposite of what you read in finance books. The bubble of misconception bursts up when events go beyond control.
The investing market is extremely volatile regardless of the assets you buy. No matter how diversified an investment portfolio you have built, there is always a risk of losing your money. Your ultimate goal should be to maximise your investing assets rather than picking up risk-free assets which are not so risk-free.
This blog evaluates how risk-free assets are truly risk-free. The study has been done based on the assumption that investors are risk-averse.
A risk-free investment is one that has no risk at all, which means you will not lose money despite the volatile nature of the market. Risk-free assets only exist in theories. In real life, there is no asset that does not include any risk. The investment world is volatile. All kinds of investments, including those that are considered safer than shares, are subject to some risks. Only the government treasuries are considered risk-free assets because they are backed by the government and its good faith policy.
Experts suggest that no investment could be considered absolute risk-free. The only difference is that some assets involve very slight risks while others involve greater risks. When assets do not seem to drop in value or become worthless, they are considered risk-free. Government-backed treasures involve the slightest risk compared to others, which is not considered bothersome at all. Therefore, people call them risk-free assets.
Some important considerations about risk-free assets include but are not limited to:
A fixed deposit is the best investment when it comes to safe returns, but if you choose a longer period, you do not receive high returns.
A risk-free rate of return implies that assets are not subject to any amount of risk. There is no possibility of losing even a single penny. In other words, you can say that these assets guarantee the return. However, this is absolutely a theoretical statement. Why returns on some investments are considered risk-free is that their returns are compared to other assets? They might be offering, but there is a 100% possibility of receiving money down the line. However, other assets, including shares that offer higher returns, could become worthless by the time dividends become due. In the case of risk-free assets, returns are low but expected returns and actual returns are the same. However, actual returns could be much lower than expected returns from volatile assets.
The term risk-free is used vaguely when it comes to risk-free assets. There are various types of risks, but it is not defined what kind of actual risk is not to be borne by an investor if they tend to purchase risk-free assets. In relation to any type of investment, risk can be divided into three categories: absolute risk, relative risk and default risk.
The absolute risk could be easily quantified by several measures, such as standard deviation. This risk is extremely low in risk-free assets because they, more often than not, mature within less than three months. If you are looking to invest in risk-free assets using loans, you can. But make sure that you choose the best interest rates in Ireland.
Relative risk is calculated by the fluctuation of the price of an asset. Note that this risk cannot reveal much about absolute risk because it only explains how risky an asset is in terms of the base. Relative risk cannot be applied to risk-free assets because it does not work for short-term assets.
Default risk is applied to short-term zero-risk assets such as treasury bills. This means the risk is to be borne by investors only when the government makes a default on its debt obligations. Normally, experts do not suggest taking out loans in order to invest money, even if you prefer to buy treasury bills. Absolutely risk-free assets do not exist on the market. You should rather create a diversified investment portfolio based on your risk tolerance capacity.
Risk-free assets exist in books, so if you are planning to invest in risk-free assets, you cannot find any of them. All types of investments are subject to some forms of risks, which vary by degree. Treasury bills are considered the safest and risk-free assets because it is assumed that the government has the potential to back such investments. Treasure bills mature in a short period of time, so you will not lose any money.
However, they will not serve the purpose of investing money at the same time, which is building wealth. If you choose long-term, risk-free assets, the return is so small that it would not be able to outpace inflation. It means you may think there is no risk of losing money. You will certainly receive the expected amount of money. But in relation to soaring prices, you will see a significant fall in the value of money you have.
A risk-free return is a theoretical concept. In the real world, there is no asset which is not subject to risks. Treasury bills are considered risk-free because the possibility of losing money is when the government fails to discharge its debts.
