Time to read: 6 minutes
Everyone knows that investing in the stock market is risky. That’s why many people avoid it, right? It’s true, there are some risks to consider. But not all risk is equal. If there’s a secret to investing, it’s simply getting to grips with the risks – and the potential rewards – involved. That way, you can calculate how much risk you’re prepared to take and choose investments accordingly to help you achieve your goals.
If you’re new to investing, that might sound easier said than done. But it doesn’t need to be hard. This short guide explains what we mean by risk and what it could mean for you. As to whether investing is worth the risk, in a few minutes, you should be in a better place to decide.
What is investment risk?
Broadly speaking, investment risk is the possibility of losing the money you invest. There’s a risk than you might not get back what you put in. There’s also a risk that you might not earn what you expect to.
The outcome of your investment is uncertain for a number of reasons. The markets could do something unexpected. A firm whose shares you own could hit the headlines for the wrong reasons. And currency fluctuations could impact the value of your investment.
It’s human nature to crave certainty. So why take a risk with your money? Well, in a nutshell, it gives your money the best potential to grow above and beyond inflation.
Risk and return go hand in hand
Perhaps the most important thing to remember about investing is that risk and reward are closely linked. You can’t have one without the other. The lower the risk, the lower the potential returns. The higher the risk, the higher the potential returns – although what you can expect and what you actually get may differ.
If you’d rather prioritise protecting the value of your money, you’ll have to sacrifice the prospect of greater returns. Finding the balance between the highest possible return and lowest possible risk will depend on your attitude to risk and how long you can invest for.
Can you tell how risky an investment’s likely to be?
When you invest in funds, you’re investing in a ready-made basket of investments which contain a range of investment types – also known as assets classes. The 4 main investment asset types that funds can invest in are as follows:
- cash/money markets
- fixed interest
Usually, cash is considered the lowest-risk asset type, and shares/equities the highest risk.
Funds are assigned a risk profile by the fund manager, which gives you a good indication of how bumpy the road is likely to be. Funds with the lowest risk profile are the least volatile and funds with the highest risk are the most volatile.
If you’re a cautious investor, you may only want to take a small amount of risk to try and achieve a modest and relatively stable return. If so, funds with a low risk profile could be right for you
If you’re comfortable taking a larger amount of risk with your money, you might want to go for funds that have a higher volatility to give you the potential for higher returns. If so, funds with a higher risk profile could be more suitable for you.
Can investment risk be managed?
While investment risk can’t be eliminated, it can certainly be managed.
The saying ‘don’t put all your eggs in one basket’ applies perfectly to investments. Instead, you could consider putting your money in a range of investments. That way if one loses money, it could be balanced out by your other investments. This is known as diversification and it can be an effective method for spreading your risk.
Perhaps the easiest way to diversify is to buy into a multi-asset fund. These funds contain many investments, rather than just one, so they can be less risky than buying individual shares in a single company. Bear in mind that funds are assigned different risk profiles and that some funds are rated as high risk.
When a fund manager puts together a multi-asset fund, they hand-pick a mix of asset types to cater to a specific appetite for risk. Lower risk funds will typically be made up of cash and fixed interest assets. Higher risk funds will usually feature more shares/equities.
Another benefit of multi-asset funds is they’re professionally managed to ensure that they maintain their risk level. Again, this can make them less risky than investing directly in shares, whose performance is often at the mercy of unexpected events.
How does time affect risk?
If you’re likely to need your money within 5 years, investing might not be right for you. You should think of investments as medium-to-long term commitments, meaning you should be prepared to hold them for at least 5 years to give your money its best chance to grow.
That’s why you should always have between 3 and 6 months’ worth of expenses saved in an emergency fund before you start investing. That way, if the markets have a wobble, you won’t have to sell before your investment has chance to recover.
Another way that time affects risk is in terms of when you plan to need the money need for your goals. This is what’s called a ‘time horizon’. The longer your time horizon, the more risk you can afford to take because you’ll have more time to recover from any market downturns.
When you’re young, you can afford to place your retirement savings in a more aggressive portfolio. As you get closer to retirement, you’ll generally want to be more conservative as you’ll have less time to ride out any turbulence.
It’s also worth adding that your attitude to risk may differ for different goals.
With a school fees fund, you’re saving for a fixed amount so you may want to be cautious with the risk you take. Whereas with a ‘Ferrari’ fund, the return is more important than the money so you could you could afford go all-out adventurous here (one can dream, right?).
What does all this mean for me?
At the end of the day, it’s your money. You need to be fully aware of the risks involved so you can be comfortable with any risks that you decide to take.
If you feel ready to choose your own investment, take a look at our investments page.
And if you’re still not sure, you could ask for some investment advice. We’ll ask you a series of questions to help you to work out whether to invest, how much you can afford to invest and – importantly – how much risk is right for you.
Good to know: our advice services involve a one-off advice fee and financial eligibility criteria apply.