Video: Understanding risk in relation to your investments
How do you decide the 'right' level of risk for you?
All investments carry a degree of risk but some naturally carry more than others.
In considering what is appropriate for you, there are three key areas that we consider.
Over the long term, a diversified portfolio will normally increase in value – and the longer the timespan, the more likely it is to show a profit.
However over the short term, investments always experience ups and downs – and occasionally, big drops in value. These are usually temporary: in years to come, what seemed nerve-racking at the time will normally be looked back on as temporary and irrelevant.
If a low point coincides with you wanting to take money out (and you don’t have the flexibility to delay until things have improved), you could get back less than you paid in. This is why investing for a set point in time is different from investing just for general future wealth creation.
2) Capacity for Loss
This is about how much risk you can afford to take, or put another way, how much money you can afford to lose.
For some people, even quite a big investment loss wouldn’t jeopardise their future plans or standard of living (a high capacity for loss). On the other hand if the fund was, say, the only money the person had to retire on, and they couldn’t make do with less, they would have a low capacity for loss.
The flip side of this consideration can be when a person has a ‘requirement for risk’ – that is, they need to take a certain amount of risk in order to have a chance of achieving the investment returns they need to meet their goals.
3) Personal Attitude to Risk
This is your personal preference in terms of risk-taking vs. caution.
Despite knowing the importance of riding our ups and downs, most people don’t quite have the nerves of steel needed to invest wholly in the most adventurous investments, with the wide and frequent swings in value that can bring. Therefore, most people prefer a middle-way in which investments are chosen so as to temper and moderate the riskiness (and also the potential return, of course).
We use a seven-level scale for this, from ‘Very Cautious’ to ‘Very Speculative’.