One of the key decisions you need to make when investing is how much investment risk you want to take.
Weighing up the level of risk you’re willing to be exposed to can be challenging. It’s often one that’s ruled by emotions and your personal attitude to risk. While these factors should play a role, they aren’t the only areas you should be considering. Whether you’re reviewing your pension or building a personal investment portfolio, balancing risk is a crucial part of the process.
If it’s a step you’re taking, keeping these six points in mind can help.
1. Investment goals
Your investment goals should be at the centre of any decision you make. If your goal is to ensure your savings keep pace with inflation, for example, you may be able to achieve this with a relatively low-risk profile. If, on the other hand, you want to grow your money above and beyond the rate of inflation, taking a greater amount of risk could help you achieve your aims.
As a general rule of thumb, the greater the level of risk an investment poses the higher the potential return. However, you do, of course, have a greater risk that your investment will decrease in value.
Your motivation for investing will undoubtedly have an impact too. If you’re investing to help pay for your child or grandchild’s education, you might want to take a more cautious approach. In contrast, if investment returns will be used to fund luxuries in retirement, taking on more risk may be appealing.
2. Investment timeframe
How long will your money be invested for? This is a factor that is likely to be linked directly to your investment goals, and it should also influence the level of risk you’re willing to take.
Stock markets do fluctuate. However, when you look at the long-term trend, investments have risen at a pace above inflation. Ultimately, the more risk you take on, the more volatility you should typically expect. So, if you’re investing for a short period of time, a more cautious approach might be advisable. However, if you’re looking to invest for a longer period, you’re in a better position to ride out the dips.
Generally, you should look to invest for a minimum of five years.
3. Capacity for loss
When you think about the money you want to invest, what would happen if it decreased in value or you lost it? Your capacity for loss should play a crucial role in deciding how much investment risk you want to take.
Clearly, if you’re in a position where you have enough disposable income to invest and don’t have to worry about the immediate impact volatility might have on your lifestyle, you’re likely to be in a better position to take more risk.
The saying ‘don’t put all your eggs in one basket’ certainly applies to investing. Diversifying your portfolio can be important. As a result, taking a look at the existing investments you hold should inform your decision.
Diversifying gives you an opportunity to create a balance that suits you. If you hold potentially high-risk global equities, for example, you may also choose to partially invest in bonds that are usually deemed lower risk. This might offer more stable growth, that could help to offset stock market uncertainty.
If you’d like help reviewing your current investment portfolio in order to understand how to diversify, please contact us.
5. Other assets
On top of your existing investments, take some time to look at your other assets. From savings accounts to your home, understanding your wider financial position can help you see whether investing is the right option for you and, if it is, the level of risk that’s appropriate.
If your finances and lifestyle are relatively secure, you may find that you’re in a better position to take greater investment risk. However, if your comfort would be affected should investment values fall, or you want to withdraw your money in the short term, taking a more cautious approach or an alternative route entirely may serve you better.
Remember that investing isn’t your only option. Depending on your circumstances and goals, you may find that alternatives, such as using a Cash ISA (Individual Savings Account), is more appropriate for your needs.
6. General attitude
While thinking about how much you can afford to invest and what your other assets are, consider your general attitude to risk. Some of us are more inclined to take a large risk for the chance of a larger reward at the end. Others will prefer a more cautious approach to life and their finances.
You need to feel comfortable and confident in your investment decisions, including the level of risk you’re exposed to. Your risk profile should reflect both your situation and your goals.
If you’d like help to understand risk profiles and the options open to you, please get in touch. We’re here to help you weigh up the pros and cons of taking investment risk and what it could mean for your finances.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.