As a caring and supportive organisation, PS&SR Branch, from this issue onwards, publishes this series to raise officers' awareness and knowledge of healthy financial management, investment traps and ability to struggle against adversity.

Most people will tell you that high risk brings high returns. Of course the first point to make is that this is only half the story! Instead of high returns you could suffer serious losses and in extreme cases, you could even lose more than you invested. It is also possible to accept high risk and not achieve a high return even if things go your way!

Consider a simple bank deposit that, let's say, offers a two per cent return. This would be considered a low-risk investment. However, instead of putting your money in the bank you could give it to me and I will also give you a two per cent return. Of course nobody would do that! Everybody understands that lending to me is riskier than putting the money in the bank, and if they lend to me they would require a much higher potential return.

Generally speaking, taking on increased risk will be accompanied by the possibility of increased return - otherwise, as in the example above, nobody would accept the increased risk. However, understanding the risk and return of investment opportunities is rarely as obvious as the example above. Let me briefly summarise three points.

Think of risk and return as relative

The potential extra two per cent must then be judged against the increased risk of Product B. For investors who want to maintain a low risk profile, Product B may not ever be suitable for them regardless of the potential return. For others, the extra two per cent will not be enough to reward them for the increased risk relative to a low-risk deposit. Some others may feel that an extra two per cent is enough to compensate them for the additional risk and will make the investment.

The key point, however, is that you must understand the risk and return before you can decide. What risks are you accepting? What factors will influence the return on the investment? How much could you lose? Against this, what potential return will the investment give you?

Investment products do not have absolute risk categories

Furthermore, given the complex nature of investment vehicles and the increasing intricacy of financial markets, many products can no longer be put into these simple categories. The risk of certain "hybrid" products can often be very different from what you might assume. Investors must ensure that they understand the specific product that they invest in and their investment advisors must also take care to ensure that this is the case.

Credit-linked notes (CLNs), as an example, are structured debt instruments under which payments of interest, principal or both can be impacted by, among other things, the occurrence of "credit events" in relation to a number of underlying "reference" entities. The investor needs to understand, among other factors, that he is effectively issuing credit insurance on the reference entities. The underlying security arrangements that back CLNs also can involve complex swap arrangements and can also have credit exposure through further credit insurance policies. However, investors have a right to have the features of a product explained to them before investing and they should ensure that they understand the risks they are exposed to by these types of arrangements.

Risks are not constant and may change over time

In the recent market downturn, many investments that may have previously been considered of low or medium risk have suddenly become much riskier. Companies that were once considered blue chip investments are suddenly in trouble. Events that had been considered very remote have suddenly become much more likely. The credit crunch, the financial crisis, the poor global economic outlook and the related market volatility, together, have turned many low and medium risk investment decisions taken in recent years into high-risk holdings for investors.

To invest, you have to do some homework and ensure that you fully understand the targeted investment as well as your own risk profile. Some of the basic questions that you should ask would include:

* How does the product work?

* What are the risks associated with the product?

* Can I cope with the worst scenario, such as losing the entire principal?

* Do I fully understand the documents I am being asked to sign?

Extract from Dr Wise Column of Securities and Futures Commission website at www.investedEd.hk