In the world of investments, most of us would jump at the chance to grow our money substantially, safe in the knowledge that there was no chance of losing anything.
Unfortunately those opportunities don't exist.
In a sense, every financial decision we make involves risk. Even if you keep your money in a safe, you're running the risk that if prices increase what you can buy with your money will be less.
Then there's the more familiar kind of risk: if you put money into the shares of a company which fails, the value of those shares could reduce to zero.
Getting an understanding of the different investment risks – and deciding how much risk you're comfortable with – is an important step to planning for a healthy financial future.
Five steps to understanding risk
Please read each of the five steps carefully
1. What is investment risk?
- High risk funds have the potential to make a lot of money – but equally all the money invested could be lost.
2. What is volatility?
- Volatility refers to how often, and how far, an investment's value rises and falls over time.
- Investing in funds with high volatility could mean having very little money at a time when it's needed – but such funds often bring more opportunity for high returns. Lower risk investments tend not to change as much over time, but can offer lower returns.
- Overseas investments involve an additional layer of uncertainty: exchange rates. If funds are withdrawn when the exchange rate is poor, the investor may not get as good a return on their investment.
3. The effect of inflation on investments
- Risk occurs when savings don't grow as quickly as prices increase, so the value of money becomes less over time.
- No-one knows how quickly prices will increase in the future, the average annual inflation rate in the UK over the past 10 years has been around 2.7% (as measured by the Consumer Prices Index).
- The table below shows what something that costs £100 now could cost in the future, depending on inflation.
|What you'd need to buy goods that cost £100 after…||Average annual rate of inflation|
4. Why time is important
- For most people, it makes sense to keep part of their savings to hand ‘just in case'. This might mean choosing an account that combines very low risk with instant access.
- Investors with long term goals – paying school fees, perhaps, or retirement planning – might need a longer period of investment.
- In the very short term, the risk of losing money from a more volatile investment could outweigh the inflation risk involved in holding a low-risk product. But as the length of time increases, this starts to reverse.
5. Reducing investment risk
- By investing in different types of assets at different levels of risk, poor performance in one could be balanced by good performance in another. Of course this depends on the type of assets invested in – each situation will differ.
- Taking a high-risk approach to investing may lead to a high pay-off – but it might also lead to a loss, since riskier investments are more likely to come unstuck. A low-risk approach may be safer, but might not bring in as much reward. Investors may want to balance their investments in line with the overall level of risk they want to take.
- Most investments will rise and fall in value over time, with the most volatile types showing larger and more pronounced swings than lower risk types.
- Investing a regular amount over a period of time reduces the overall risk being taken. This is because more of an asset is bought when its price is low and less when it's higher.
- A risk-targeted fund invests with the aim of keeping to a certain level of volatility, which could be high or low.
Understanding different attitudes to risk
Nobody but you knows what level of risk you're comfortable with but you might find that hard to pin down when investing your money. We’ve created a number of profiles outlining different types of investors and the level of risk they are likely to be comfortable with.
Savings…for those who want to keep what they’ve got
A typical investor will:
- Be uncomfortable with the thought of losing the money they already have
- Be happy to prioritise capital protection over growth potential
- Understand increases in the cost of living will reduce how much they can buy with their money in the future
- Understand that to achieve higher returns without taking investment risk they may need to lock their money away for a fixed period of time.
Lower to Medium
An investment which carries some risk…investors won’t want to see too many ups and downs
A typical investor will:
- Be looking for a better return than bank or building society accounts usually offer, but want to limit the amount of risk they’re taking
- Understand that keeping potential losses down will also limit how much their investment could earn
- Know that the value of an investment can go down as well as up and that they may get back less than they invested
- Realise that unlike a bank or building society account, the value of these investments will fluctuate meaning that investors may need to wait in order to optimise when they take their money.
Medium to Higher
An investment with a level of risk that sits somewhere in the middle. Investors should be comfortable with the balance between risk and growth
A typical investor will:
- Be looking for returns above inflation and won’t mind taking some risk with their money to get there
- Be prepared to see daily changes in the value of their investment and will understand that they could get back less than has been invested
- Prefer to spread risk by investing in a wide range of assets
- Accept that including some lower risk assets may limit the potential returns that they could make.
An investment with a high level of risk. Investors should accept that they will see swings in the value of their investment
A typical investor will:
- Want returns above inflation and won’t mind taking risk with their money to try to do this
- Prefer to invest in higher risk assets for the potential higher growth, rather than lower risk assets which aim to limit losses
- Know that higher potential returns mean that they’re likely to see the value of their investment go up and down every day
- Accept that there is an increased possibility that the value of their investment will go up and down and they may get back less than has been invested.
Our investment products
A stocks and shares ISA that allows you to save in a tax-efficient way. Please note that we don’t currently offer a cash ISA. You can access a broad range of investments through a single account you manage online.
Allows you to build up a retirement pension fund in a tax-efficient way. You won’t be able to access the money until you’re 55.
Offers access to a broad range of investments through a single account you manage online. This could be an option for people who have already used up their annual ISA allowance.
Call us now for more information
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Calls from UK landlines and mobiles are free.
For our joint protection, telephone calls may be recorded and/or monitored.