Investment basics: what's a little risk now and then?

Understanding your risk tolerances, the biggest risk is to take no risk at all.

 

How much risk are you prepared to take when making your investment decisions? It's important to understand your view of risk and its impact on your investment goals. 

 

Remember there is no growth without some level of risk, but striking the balance between risk and return is a challenge that can be achieved with careful planning.

 

What is investment risk?

 

Investment risk is the probability that your financial goals won't be reached. Risk is a result of fluctuations in the market and therefore investment risk relates to the potential for your investment to go up or down. In general, the higher the risk, the higher the return.

 

All investments carry some form of risk and you need to be comfortable with the amount of risk you are willing to take. Certain factors impact on your decision to take a higher level of risk and these include:

 

- How much money you need to reach your goal.

- The time frame you have in order to meet your goal.

- Whether you would accept your investment falling behind inflation.

- What the return offered by other investments is.

 

These questions will help you balance the risk and reward equation and should help to confirm that taking risk is a necessary part of investing.

 

In fact the biggest risk can often be taking no risk at all because your investment won't have the growth potential to achieve your goals.

 

What is your risk profile?

 

Financial advisers are skilled at working with clients to determine the level of risk a client is comfortable with. Some indicators of a client's view of risk might include:

 

- The importance of long-term growth over fluctuations in an investments value yearly and monthly.

- Attitudes towards investing money in shares or keeping it in the bank.

- Reactions to a reduction in an investment by 10% in one year.

- Ability to leave your investment for a planned time frame.

 

In general, people who are comfortable with a moderate level of risk are usually looking for opportunities to maximise long term capital growth.

 

Ways to manage risk

 

Choose an appropriate investment option

 

Once you have some understanding of your risk profile you can now look at the trade-off between risk and return over various investment options. The graph below shows that cash carries low risk but also a low level of return. At the other end of the scale shares carry the highest level of risk but also provide the highest level of return over time. 

 

Take the time to invest

 

Investments move in cycles and knowing your investment time frame will impact your investment choices. In general more volatile investments (those that fluctuate in the short term) aren't recommended if you are likely to need the money in the short term. If you plan to keep your investment over the longer-term, fluctuations in the market should even out. 

 

Diversification

 

Diversifying your investments is another way to reduce risk. Choose to spread your investment across a number of investment types, classes and companies. Consider choosing more than one fund manager and also look at having a mix of shares, property and cash. Buying a broad range of investments is not often possible, so managed funds can be a good option. 

 

Regular Investing

 

Making regular investment contributions or reinvesting your income distributions instead of taking them as cash is one of the best ways to reduce market ups and downs. The reason for this is that when shares or unit prices are down your investment buys more and when prices are up these units are worth more. At the end of a long-term investment horizon you will generally end up with a greater accumulated value. 

 

Set a clear objective

 

Setting your financial goals with your adviser is one of the most effective ways of reducing investment risk. Making a long term commitment to some basic investment strategy can reduce risk in the long term and helps to reduce the temptation of shifting your investment for short-term gain.

 

The golden rules of investment

 

- Select sound investments with growth potential

 

- Monitor investments to make sure they are sound

 

- Invest a fixed sum at regular intervals

 

- Diversify your portfolio

 

- Don't respond to short-term market fluctuations

 

Tips

 

- Invest a fixed amount of salary every month before spending it on other things

 

- Set up a monthly direct debit from your bank so you don't forget to invest

 

- Re-invest your investment income to buy additional units or shares and benefit from compound returns

 

Understanding your level of risk and then actively managing that risk is necessary if you are to achieve your financial goals. Remember that taking no risk is the biggest risk you can take and you owe it to yourself to make your money work as hard as it can.

 

For more information on risk and your investment opportunities contact your financial adviser. 

 

This article is intended to provide general advice only, and has been prepared without taking into account any particular person's objectives, financial situation, or needs. Before acting on the advice, you should consider its appropriateness for your own circumstances. This is best done with the assistance of your financial adviser.