Investment risk is the possibility of losing the money you invest, or not achieving the expected returns.
The uncertainty of investment outcomes stems from a number of reasons of which include:
The markets do something unexpected
Negative publicity affects a firm in which you hold shares
Currency fluctuations impact the value of your investment
The natural human incline is towards certainty, so why take a risk with your money? Taking calculated risks with investments provide the opportunity to beat inflation as investments can and hopefully appreciate over time.
Section 1: Finding the Sweet Spot: Balancing Risk and Return
Risk and return are connected. If you want to get more return from your investment, you may need to take a higher risk. But if you want to be more cautious with your investments, you may have to accept lower returns. Keep in mind that the outcome you expect may not always match what you actually get.
To find the right balance between risk and return, you need to consider your willingness to take risks, and the amount of time you can invest your money.
Section 2: How Risky is this Investment?
When you invest in funds, you're putting your money in a group of different types of investments, also known as ‘assets classes’.
These can be split into 4 categories:
Cash/Money markets
Fixed interest (Bonds)
Property
Equity (Stocks)
Cash is typically considered the lowest risk, and equity the highest risk.
Fund managers assign a risk profile which tells you how volatile each fund is likely to be. Those with the lowest risk profile have the least ups and downs, while those with the highest are the most unpredictable.
If you prefer low-risk investments, you might choose funds with a low risk profile. These can give you modest and stable returns. But if you're willing to take a higher risk for potentially higher returns, you might choose funds with a higher risk profile. The choice depends on your comfort level with risk and how long you are willing to invest.
Section 3: Can you Manage Investment Risk?
Although investment risk cannot be completely eliminated, it can be managed.
One way to manage investment risk is by diversifying your investments, which means spreading your money across various investments. This can balance out the risk, so if one investment loses money, it could be offset by gains in others.
Investing in a multi-asset fund that includes multiple investments is an easy way to diversify your portfolio and reduce risk.
A multi-asset fund is put together by a fund manager who selects a combination of different types of assets to match a certain level of risk. Funds with lower risk profiles usually include cash and fixed interest assets, while those with higher risk profiles tend to feature more stocks and equities.
Multi-asset funds are managed by professionals who ensure that they maintain their intended risk level. As a result, they can be less risky than investing directly in stocks, which are often influenced more by unexpected events.
Section 4: The Relationship Between Time Horizon and Investment Risk
Generally, risk tends to decrease as the investment time frame increases. Market volatility and risk are typically lower over longer periods of time.
Investing should be considered a medium to long-term commitment. To give your investments the best chance to grow, it's recommended to hold them for at least five years.
Ideally you should have an emergency fund of three to six months' worth of living expenses before you start investing. This way, you won't have to sell your investment during market downturns before it has a chance to recover.
The longer your time horizon (time to reach your money goals), the more risk you may be able to take. If you have a long time horizon, you may be able to afford more risk as you will have more time to recover from any market downturns.
For example, if you are young you can afford to place your retirement savings in a more aggressive portfolio. However as you near retirement, you may need to be more cautious with your investments as you will have less time to ride out any turbulence in the markets.
Section 5: The Relationship Between Your Goals and Investment Risk
Similarly, your goals can also affect your attitude to risk. For example, if you're saving for a down payment on a house, you may want to be cautious with the risk you take. Whereas with a luxury holiday fund, the return is less important than the experience, so you could afford to take more adventurous risks with your investments.
Conclusion
Ultimately, it’s your money so it's important to understand the potential risks involved. You should only invest if you’re willing to accept a certain level of risk and feel comfortable with the potential outcomes.
Taking the time to research and discuss with professionals is a good first step. Charles James offers a free initial consultation in order to help you find clarity in your goals and help guide you in the right direction.
Head to www.charlesjames.com/contact-us to find out more.