Understanding investment risk

Understanding investment risk

If you are looking to invest a proportion of your wealth, with a view to achieving your financial objectives, it is important to first understand the level of risk you are comfortable taking.

Introduction

Like many things in life, investing your wealth comes with an element of risk. When it comes to investment risk, this can be defined in simple terms as the likelihood of your investment portfolio losing value.

Many factors influence this risk, and it can also vary depending on the type of investments you are involved with and when.
 
Guiding you through the complexities of investing, the associated risk and how these fit into a comprehensive, tax-efficient financial plan is where an expert financial planner can provide value.

Attitude to risk and capacity for loss

Before you invest your wealth, a financial planner will look at how much you can realistically invest, for how long, and how this could help you achieve your financial objectives. This will involve completing an assessment to find out more about your ‘attitude to risk’ and ‘capacity for loss’.

  • Attitude to risk – your feelings related to uncertainty and a potential fall in the value of your investment portfolio.
  • Capacity for loss – your ability to sustain a fall in the value of your portfolio without it having a detrimental impact on your objectives, financial stability or long-term security.

Without an understanding of both, a financial planner cannot deliver a suitable recommendation that reflects you, your circumstances, and your aspirations for the future.

This assessment will consider your:

  • income and expenditure requirements;
  • health and living circumstances, with focus placed on whether you expect any changes to these;
  • objectives and the timescales associated with these; and
  • existing investing experience and how involved you wish to be with the management of your investment portfolio.

A complete assessment allows your financial planner to recommend investment solutions that take enough risk to meet your circumstances, whilst ensuring they do not jeopardise your financial security. It is all about finding a balance. 

Diversification, time horizons, and realised losses

Understandably, the main concern many have with investing is the likelihood of them losing capital and it is likely this has crossed your mind too. It is true that the investment markets can fluctuate and have occasional periods of volatility that result in diminished values.

To help protect you against this, your financial planner will try to reduce your investment risk by implementing a suitable diversification strategy. As part of this, your investment portfolio is spread over multiple asset classes and markets to ensure you are not overexposed to risk from a single source – this means you have built in contingencies should a particular asset class or market experience a downturn.

It is important to remember that losses are not realised until the asset that has fallen in value against the purchase price is sold. As such, whilst uncomfortable, this is only impactful for you if your time horizon is short, which is something your financial planner would consider as part of your attitude to risk and capacity for loss assessment; however, if you are investing for the long-term (over five years) it is often best practice to stay in the market and wait for the recovery. Whilst history does not guarantee positive returns, it does show that remaining invested offers the potential to achieve higher returns than cash rates and inflation.

Cash deposits

These savings have the least amount of investment risk but are exposed to inflation. As such, they are best used as part of an emergency fund.

Bonds and Gilts  

Best described as loans to companies or governments that pay a fixed rate of interest over an agreed term (typically five to 15 years), with the original investment sum also being repaid at the end of this term. These are classed as ‘fixed interest assets’ and often considered lower risk, provided the institution has a good credit rating.

Shares

You purchase a share of a company in return for a proportion of their income (dividend). Whilst they can outperform inflation, cash, and fixed interest assets, they are considered higher risk because the value depends on the company’s performance and, therefore, there is no guarantee you will receive a return. If investing in overseas shares, you also need to consider currency fluctuations and geopolitical factors.

Commodities

These are physical goods, such as oil and gold. Due to their potential to fluctuate significantly, they are considered higher risk; however, as their value has historically moved differently compared to the other asset classes mentiond above, they are often viewed positively for diversification purposes.

Property

This could refer to either residential or commercial property and be direct or indirect. Returns are achieved through capital growth or rental yields. The investment risks involved are unexpected costs, lack of liquidity, and market conditions.

Striking the right balance for you

Whether you are looking to grow your wealth or simply attempting to prevent inflation eroding its value, investing could be a suitable option for you.

What is important to remember is to achieve an appropriate level of balance when it comes to the investment risk you take. Taking too little risk could result in income shortfalls or you having to extend your time horizons and delaying your plans for the future. Conversely, taking too much risk could mean you are financially vulnerable if market conditions result in your investments losing value. 

A financial planner can help you achieve this balance.

How can we help you?

Whether you are a seasoned investor or looking to invest for the first time, we can help. Our independence means we have access to the entire market and can create a suitable portfolio for you.

If you would like to discuss your investment options, or if you wish to arrange an initial no cost, no obligation, consultation, then please fill out the contact form below. Alternatively, you can call 01603 706 820 or email info@lffp.co.uk.

Important information

The contents of this article do not constitute financial advice. The value of investments can fall as well as rise and it may not always be possible to receive back the sum initially invested. Past performance is not necessarily a guide to future investment returns.

While considerable care has been taken to ensure this information is accurate and up-to-date, no warranty is given as to its accuracy. This article constitutes a financial promotion.

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