Riskometer
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Managing risk is about getting the right balance with your investments. You are more than likely to already hold one or more of the investment products listed below. But what is important is to hold enough different types of investments in the right proportions that is in keeping with your lifestyle and requirements.
Here’s a quick guide to where different investments might sit on a scale of risk.
Risk Example Investments
| High | Direct holding in one or a few shares |
| Direct holdings in a larger number of shares | |
| Equity Funds e.g. Emerging Markets | |
| Equity Funds e.g. UK and International | |
| Managed Funds | |
| Property | |
| Gilt (i.e. Government bonds) and Corporate Bond Funds | |
| Savings Account/Cash ISA | |
| Low | Directly held Gilts/National Savings & Investments |
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The above investment types are not an exhaustive list but help to illustrate the general principle behind investment choices based on an undetermined time period for investment.
This table is only a general indicator of relative risk and does not relate to specific circumstances, where risk can vary depending on the relevant market conditions at the time.
Two important concepts that the above table also does not address are those of volatility and the relationship between risk and return.
Volatility
How often and by how much an investment has gone up and down in value tells us how volatile it has been. Based on those past experiences experts try to predict how volatile an investment might be in the future. Of course nobody has a crystal ball, but when choosing an investment it’s an important consideration.
Why? Because when choosing investments it’s important to consider how the investor will react to changes in the value of their investment over time. An investment with high expected volatility will go up and down more often and probably by a higher amount than an investment with low expected volatility. Therefore it’s up to the individual, whether they are being advised or not, to choose whether they can withstand this fluctuation in the value of their investments.
The reason you might be prepared to withstand short term variations in the value of your investments is explained under Risk and Return below.
Risk and Return
The relationship between risk and return is generally considered to be the higher the risk you take the higher the potential return.
However the story is a little more complicated than that. The higher the risk, the higher the potential return for sure. However investors must also consider that the higher the potential risk then the higher the potential for loss.
This possibility for high returns or significant losses, at least over the short term, is what is meant when people talk about volatility. Higher risk assets are considered to be more volatile.
The reason people take on these higher risk assets is because they understand it is a long term game and that short term movements in value were accounted for when they made the investment. Plus, they are prepared to take on the risk because they wish to pursue the higher potential returns over the long term.
Before making any investment always consider the return you are looking to get out of it, the risk you need to take to get that and the volatility you are comfortable with.
Choosing the right investments
Risk and return provide the foundation for making good investment decisions. But when choosing the right funds to invest in for the long term for yourself the two most important considerations other than risk and return are your own risk profile - your investor profile - and the need to spread your risk.
The reason you would need to understand your own investor profile is to ensure you put together a set of investments that are in keeping with your needs and your personal characteristics. This consideration is discussed further in this Ezine article.
One of the golden rules of investing is to spread it around. Otherwise known as diversifying your risk it means you don't want to put all your eggs in one basket, because that basket might get snatched.
The other more obvious reason why you would not want to invest in just one or two sectors is that you don't know which sectors will perform best. That's right. Nobody knows for sure which sectors will perform best in the short term, or even less so in the long, term.
Have a look at this table and realise how difficult it is to predict which sectors will perform best in the future. It's an excellent way of illustrating how difficult it is to time investments, and proof of why you should spread your investments across different areas then sit back and relax.
