Why is your attitude to risk so important?
When you invest your money the most important issue is your attitude towards risk and capacity for loss. Clearly, no one wishes to lose money, but most people are aware that for additional gain there is always increased risk.
Our risk assessment process
In order to assess and manage investment risk we follow a four step process which is highlighted in the diagram below. The purpose of this profile is to help you understand the risk associated with investing and correctly apportion risk to each individual investment.
Therefore, in addition to volatility here are some other types of risk to consider:
Inflation risk is the risk that the buying power of your capital decreases over time. A typical example of this is when you invest all your funds into one building society and the net return does not keep pace with the rise in retail prices. This means that in real terms your money is actually losing value.
Liquidity risk arises from situations where you are not able to cash in your investments and therefore your funds can become locked in for a period of time or there may be penalties imposed on early surrender. Typical examples of this are shares which are not traded daily, or when demand is low, such as a property fund where the sale of assets is needed in order to realise your investment in cash.
In order to reduce risk you should invest in a variety of assets. Diversification is the "free lunch" of finance. It means that you can reduce market risk simply by investing in many unrelated instruments such as Shares, Fixed Interest, Property and Cash. The concept is often explained with the age-old saying "don't put all your eggs in one basket."
This type of risk is the most difficult to quantify and should probably be avoided if not understood. An example of this is a complex fund not regulated by the Financial Conduct Authority or a structured product which is underpinned by counterparty.
Capacity for risk
As part of the process of establishing your attitude to risk and determining the suitability of various potential investment risk profiles, it is important to consider what is called your “capacity for risk”. Your capacity for risk is the degree to which your personal circumstances and opinions will impact the specific investment decisions we recommend.
When you align a risk level to each of your investment goals it helps to consider four areas: investment timeframe, debt repayment, your capacity for loss and investment liquidity.
Next page »
Download our short questionnaire to help you understand your attitude towards investment risk.