Risk is a term much bandied about by those in the world of finance, but it means different things to different people.
There are numerous investment options and you can ensure that you choose the right ones for you by having an understanding of the concept of risk as applied to investments, so you can make informed decisions.
What is investment risk?
Risk is essentially uncertainty and unpredictability. Share prices fluctuate, interest rates rise and fall and whilst we can make educated guesses, there are no guarantees how markets may move in the future. Inflation is another unknown quantity, but one that you need to take into consideration when calculating the real return on investment or savings
The guidelines to remember
- The greater return you want, the more risk you have to accept
- The higher the return you want from your investments, the greater the chance of losing some or even all of your initial investment
- The longer you can wait before you needing to cash in, the more risk you can afford to take
- For short-term savings, it is sensible to avoid capital risk. The reason for the investment and the amount of accessibility will have a big impact on what types of investments are right for you
- If you are investing for the long-term you can afford to take more risk
- Investing in share-based assets has proved to be the best way for providing growth that outperforms inflation. There is still risk but, when you invest over the long term, there is more time to recover your losses should stock markets fall
- Investments need to be managed and reviewed as not doing so simply increases the risk of underperformance
Different types of risk
- Inflation risk – the threat of rising prices eroding buying power.
- Capital risk – the possibility that you may not receive back the amount you invested.
- Share based risk – the risk the company you invest in underperforms; shares prices are dragged down in a falling market
- Currency based risk – movements in exchange rates can work both for and against you
- Manager risk – there is huge variance in the performance of managers of collective investments
Attitude to risk
Only you can decide how much risk you are prepared to take. Some people are willing to aim for high growth and accept capital risk, whereas others are uncomfortable with losing any money, even in the short-term. Once you understand what the risks are, you can invest appropriately as the biggest risk comes from not knowing what you are doing.
How to manage your risk
You won’t be surprised if I say that you need to deal with an experienced independent adviser who understands investment risk and how to manage plans and portfolios over the long term. Most people have neither the time nor inclination to do this for themselves, but it will make a big difference to your investments.
It is my view that investors should be comfortable with the level of risk taken with their investments and to this end I will spend a significant amount of time discussing what is right for each person. After all, it is your money and you want to be able to sleep at night. I use a questionnaire to establish your view on certain issues and although there are no right and wrong answers, this can tease out how risk averse a person may be. To that we chat about what risk means, areas of investment and if any areas are of interest to you. A portfolio is then constructed that is appropriate for the individual.
Sadly, I have come across too many people who have been put into investment funds that have a far higher risk profile that they actually want and who did not realise the risk to their capital. Also of great importance is to annually review and rebalance a portfolio to ensure that you are invested appropriately as what was right two years ago, may not be right for you now.
Is the risk profile of your investments right for you? Have your investments been reviewed in the past year or so? If in doubt and you want to get some unbiased advice, please do not hesitate to get in touch.