Managing Your Investment Risk Expectation - SKerritt Consultants, Brighton

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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

    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

    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.

  • Diversification

    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."

  • Specific risks

    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.

Investment timeframe
When do you intend to use the invested money?

Short term (0 - 5 years)

If you are investing for a relatively short period, volatility may have a significant impact on the portfolio. There is less scope for returns to smooth out over shorter time periods. If more certainty in outcome is required, a lower risk portfolio should be considered. Whilst taking on risk could produce either higher or lower returns, a lower risk portfolio should be considered to provide more certainty of the outcome when the money is required.

Medium Term (5-10 years)

If you are investing for the medium term, volatility will still have an impact on the portfolio. You should be made aware of the range of possible outcomes, such as are displayed on the risk level selection screen and forecast (if applicable). If more certainty is required a lower risk portfolio should be considered. However, taking more risk could result in higher potential returns.

Long Term (10 Years plus)

 If you are investing for a longer term, any portfolio will have more time for potential market volatility to even out. In practice this means where volatility results in a period of loss, there is greater chance to achieve a recovery. This may allow more opportunity to take higher risks

No fixed term

If there is no fixed term for the investment, you should consider what level of loss you might be prepared to accept. You should also consider how likely it is that you will need to have early access to the investment.

Debt Repayment
Should you repay your debts before investing any money?

As a general rule before undertaking any investment, you should consider if it would be better to repay debts you may have. This is particularly relevant where these debts are subject to a high rate of interest, such as credit and store cards. 

Your capacity for loss
How much of an investment could you stand to lose without having a significant impact on your future standard of living?

None or very limited

Where this investment is a major part of your financial future, your ability to tolerate losses may be reduced given the impact it would have on your standard of living. Investing in a lower risk portfolio would reduce the likelihood of suffering losses, but these typically offer lower rates of return.

Small / medium risks could be tolerated

Whilst small losses could be tolerated, you should consider whether larger losses might substantially impact your future standard of living. You should ensure you understand the range of possible outcomes.

Large losses would have a low impact on future lifestyle

Where you have other secure sources of future income, the impact of investment losses on this investment may not have a material impact on your standard of living. Subject to your attitude to risk and goals, a higher risk portfolio could provide higher expected returns.

Investment Liquidity
If you needed sudden access to a lump sum, how likely is that you would encash an investment?

I have other savings and investments which I can use for most needs

Providing you don't require early access to an investment, issues around liquidity shouldn't impact the risk you are able to take.

I may need this investment if I needed access to a significant amount of money quickly

If the investment may need to be accessed within a shorter timeframe than planned for, the impact of shorter term market swings or product fees could be significant. Care should be taken around which assets will provide your accessible emergency reserve.

I would almost certainly need access to this investment

If the investment may need to be accessed within a shorter timeframe than expected, the impact of shorter term market swings or product fees will be significant unless a sufficient emergency fund is maintained in liquid assets