Risk and return are two things that must be considered when choosing an investment product. How can investors increase return, while also reducing investment risk?

Definition of Investment Risk and Return

One important part of wealth management is wealth accumulation by investing. When investing there are many things to consider, some of which are RISK and RETURN.

Risk

Investment risk can be defined as a loss due to investment activities, both systematic and unsystematic risk.

Systematic Risk

Systematic risk is external risk that cannot be avoided or controlled, for example:

• Interest rate risk which occurs due to an increase or decrease in the benchmark interest rate (formerly known as the BI Rate, or now the BI 7 Days Reverse Repo Rate)
• Inflation risk.
• Currency or exchange rate risk, which occurs due to an increase or decrease in the exchange rate of the Dollar (or other currency) against the Rupiah.
• Commodity risk, which occurs due to an increase or decrease in commodity prices, for example the price of coal.

Unsystematic Risk

Unsystematic risk is risk that can be avoided or controlled by diversifying investments. Examples of unsystematic risk:

• Liquidity risk occurs because assets are sometimes difficult to liquidate or resell.
• Reinvestment risk occurs because it may be difficult to obtain the same level of returns when assets or funds are reinvested.
• Financial risk is a risk that that affects an individual or entity’s financial position, for example, due to investing in stocks.
• Business risk.

Risk usually occurs due to price fluctuations (standard deviation or variance). Try to compare investment 1 and investment 2. Which one is more risky?

In this example, investment 2 (gray line) will be riskier.

Return

Investment gains can be interpreted as profits obtained due to capital gains or income from investments (e.g., dividends, interest, coupons and others).

Relationship of Risk and Return in Investment

The relationship between risk and return in investment is generally linear, namely HIGH RISK, HIGH RETURN and LOW RISK, LOW RETURN.

The following graph illustrates the relationship between risk and return on investment:

Source: Stillmanbank.com

Money Market Funds

Money market mutual funds are investment portfolios that contain cash (time deposits) and debt securities with maturities of less than 1 year.

Government Bonds

The safest investment (risk free) is Indonesian government bonds, because the principal and interest are guaranteed by the state.

Based on Law No. 24 of 2002 concerning Government Securities, it is stated

Article 1

In this law what is meant by:

• Sovereign Debt Instruments are securities in the form of acknowledgment of debt denominated in Rupiah or foreign currencies that are guaranteed to be paid for interest and principal by the Republic of Indonesia, according to their validity period. Several Indonesian government bond products are: ORI, SBR, Retail Sukuk, Savings Sukuk, FR, INDON, and INDOIS.

Fixed Income Funds

Fixed income mutual funds are investment portfolios that contain government bonds or corporate bonds with maturities of more than 1 year.

Corporate Bonds

Corporate bonds are bonds issued by companies. Each debt instrument has a rating, for example the rating from PEFINDO.

PEFIND ratings for corporate debt securities are categorized as:

• Superior: idAAA rating.
• Very strong: idAA+, idAA and idAA-.
• Strong: idA+, idA and idA-

Balanced FUnds

Balanced mutual funds are mutual funds that contain a mix of money market and debt (fixed income) securities, as well as stocks (equity).

Index funds

Index funds are mutual funds that follow a certain stock index, for example BNP Paribas Sri Kehati, which follows the SRI KEHATI index (focused on ESG stocks).

Stocks

Stocks are shares of ownership in a company. When buying shares, investors are buying a portion of share ownership.

Alternative Investments

Several alternative investment products in Indonesia regulated by OJK (Financial Services Authority) are P2P Lending, Equity Crowdfunding and Securities Crowd Funding.

Alternative investment products (commodities in nature) that are regulated by CoFTRA (Commodity Futures Trading Regulatory Agency) are commodity futures and cryptocurrency trading.

Sharpe Ratio: Comparison of Investment Risk and Return

The Sharpe ratio is the ratio used to compare the benefits of investment risks taken. The formula used is:

You can optimize your investment by choosing investment products based on sound investment analysis, and by staying updated on the latest information, or contact a wealth advisor to get the right recommendations.

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PT Moduit Digital Indonesia is an investment advisory company under OJK (Decree: KEP-30/D.04/2019).

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