Aviva Stocks & Shares ISA

Understanding investment risk

What risk means for your money and how to manage it

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If anyone ever asked you about risk you'd probably say you avoid it where you can. We all know that the bottom of the ladder is safer than the top. But when it comes to money, risk means something a little different.

Taking a risk when you invest can sometimes be a good thing because it could help your money grow.

The more risks you're prepared to take on, the greater the rewards could be, but the greater the risk you could lose money. With fewer risks, your money could be safer, but might have less chance to grow.

What's important is that you're in control. You can choose the level of risk you feel comfortable with. When thinking about what kind of risk you're prepared to take think about.

Time, in other words, how long you invest your money for.

All investments tend to go up and down over time.

But generally, the longer you invest your money for, the better chance it has to ride those ups and downs – and for you to come out on top.

How long is long? We'd recommend investing for at least 5 to 10 years. But remember investment values could fall as well as rise and you could get back less than you paid in.

The second thing you could do, is to spread your investments across different assets. That just means ‘don't keep all your eggs in one basket'.

Imagine if all your investments were in one basket. If it falls, you'd lose out. But if you spread them across several baskets, if some do badly, they could be outweighed by others doing well. 

If that sounds complicated, you can ask an investment manager to do this for you. They will pool your money with others in a fund, which could be made up of thousands of stocks. As there are so many stocks, it's unlikely that they will all do badly at the same time. And you're less likely to lose all your money.

Here's another tip, rather than investing one lump sum, you could invest small, regular amounts. Because investment fund unit prices vary day to day it might be more expensive or cheaper to buy depending on the price that day. So rather than investing all your money on an expensive day you'll spread the risk by buying small amounts regularly.

The fact is investing is like life you can never avoid all risk completely, but you can manage it in a way you feel comfortable with by: 

  • Keeping your investments for at least five years.
  • Spreading your investments around.
  • Deciding to invest little and often.

Using these tips could you help you choose the investment strategy that suits you and your financial goals. That's not so scary!

The Cambridge Dictionary describes risk as "the possibility of something bad happening" . It's a definition that we're familiar with in day-to-day life. Indeed, most of us try to avoid risk when we can – things like wearing a helmet to ride a bike, checking for traffic before crossing the road, or, on a smaller scale, paying our bills in advance so we don't get a fine. 

But when we talk about risk in the context of investing, it's not necessarily something you'll want to avoid. 

Intriguing, right? Allow us to explain. 

What is investment risk?

In investing, risk refers to the possibility of an investment falling in value.

As a rule, investments that have a higher level of risk usually have the potential to deliver a higher rate of return. But you'll probably have a bumpy ride along the way, riding the ups and downs of the market to get that higher return and there are no guarantees.. 

Depending on your circumstances, you might be prepared to put up with a few bumps. Or you might decide that you want a smoother ride and you're happy with a lower, but steadier, return. In that case, an investment with a lower level of risk might be more suitable for you. 

Whether you decide to be a risk taker or prefer to play it safe, the approach you take is a very personal decision – and could change over time with your circumstances. 

And we have to say it: whatever approach you choose, there will always be some level of risk. Investing by its very nature is risky, and the value of your investments can always go down as well as up, meaning that you could get back less than you put in. 

Managing investment risk

Whenever you invest, you accept there's a risk your investments may fall. But is there a way to minimise that risk? Here are some things you can do to try. 

Take your time 

All investments go up and down over time. But generally, the longer you invest, the more chance your investments have to ride the ups and downs of the market — and the best chance you'll have of making a return on your money. That's why investing for the long term (at least five years) is a good idea. 

If you're a pension saver under 45, for example, you're in a great position to invest for the long term and accept more risk. With at least a decade until you can legally access your savings and, more realistically, nearer to 20 years before you will, your investment should have enough time to withstand any market dips.

Don't keep all your eggs in one basket 

If you keep all your eggs in one basket, there's a risk that you'll lose them all if that basket drops. It's the same with your investments. Make sure you're investing your money in lots of different things, like shares, property and bonds, for example. Diversification is the technical term. With diversification, if some of your investments are doing badly, potential losses may be balanced out by other assets performing well. 

One way to diversify is by pooling your money together with other investors in a fund. Here, a fund manager will decide what to invest in on your behalf and could invest in hundreds of assets within one fund. So it's less likely that you'll lose all your money, as all your assets would need to perform badly at the same time for that to happen.

Depending on the type of fund, hedging may also be used to minimise investment risk. Hedging simply means that the fund manager takes insurance against the value of their investments falling, or against the possibility of missing out on a rise in the value of an investment. 

Or smoothing may be used, where the fund manager holds back some of the returns earned during periods of good performance and uses them to reduce losses when things aren't going so well. 

Spread your investments over time 

Investing small amounts on a regular basis, rather than a lump sum up front, could help to spread your risk. This is known as pound-cost averaging. Buying shares in small amounts over a period of time means sometimes they will be expensive, and sometimes cheaper – so you get an average cost over time. 

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