understanding Investment Risk
When choosing to invest your money it’s important to understand a little more about the types of investment you can make and how much financial risk is involved with those investments.
Set out below are the things you should consider before investing and how we’ll help you make the right investment choices.
Understanding your savings goals
It’s a simple question, but are you saving for the near future or making an investment for the longer term – perhaps for retirement?
Deciding what you want your investment to achieve is important, because it’ll help when making decisions about where to put your money to achieve your financial objectives. When deciding how to invest your money you’ll need to think about:
• The level of investment risk you feel comfortable with.
• The investments available to you.
This Pensions video was provided by Zurich Life Pensions
What is investment risk?
When investing money we always hope it will go up in value and when the time to take it out comes, our investment will be worth more than when we originally paid in. However, all investments have some investment risk associated with them – it’s important to remember:
• The value of investments can go down as well as up and you may get back less than you paid in.
• That inflation could reduce the value of the money you invest.
Higher risk investments, such as stocks and shares, offer the potential for higher returns but because the values can change quickly you are at risk of losing the money you invest especially if you need to access your money quickly.
Lower risk investments, such as government bonds, offer lower but more stable returns and less chance of losing the money you invest. But, lower returns may mean that inflation reduces the value of your investments.
The ‘ups and downs’ of investments
The value of investments or the income they pay can go up and down over time. The speed and extent of changes in values is known as volatility. The more an investment value fluctuates, the more volatile that investment is and the more investment risk it has.
Holding shares in a single company is an example of a highly volatile, high risk investment because the value of the shares will change quickly over time. There is the potential for high returns if the company performs well, but also the potential for large loses if the company performs badly. You could lose the full investment if it goes out of business.
Holding UK government bonds is an example of a low volatility, low risk investment because the value of these bonds and the income they provide is quite stable. There isn’t much chance you’ll lose your money, but investment growth will be low and if it’s lower than inflation, the value of your money will reduce.
Other types of investment risk
Other factors that affect risk include, but not limited to:
• Changes in exchange rates
• Having too much invested in single companies, industries or market sectors
• Changes to legislation
• Investments in small companies
• Investments in new and emerging markets
• Investments linked to commodity markets
How much investment risk should You take?
You need to think carefully about how you feel about your money and how much investment risk you’re prepared to take to get potentially higher investment returns.
Ask yourself:
- How much money do I need to meet my financial objectives?
- Can I afford to lose the money I’ve invested?
- How would this affect my lifestyle? Would I risk the money I’ve invested for potentially higher returns?
Attitude to Risk
Attitude to risk will depend on your circumstances and financial objectives and can change over time.
Your ‘attitude to risk’ describes the level of risk you’re willing to take on a particular investment, taking into account all your circumstances. We need to know this to help make the best investment recommendations to you. The aim is to find the right balance between what you want to achieve and how much risk you’re willing and can afford to take.
Things to think about that affect your attitude to risk
Your personal circumstances – how much you can afford to lose if things don’t work out as expected. How much you can afford to lose or are willing to lose, is sometimes referred to as ‘your capacity for loss’. Sometimes it helps to put a number on this, for example losing 10% of the money you invested may not be a problem but 20% might be if it would significantly affect your lifestyle.
Your investment goals and how long you want to invest. Your attitude to risk will be different depending on what you’re saving for. For example, if you’re saving into a pension and are a long way from retirement, you may want to take some risk but if you’re closer to retirement you may want to take less risk and be more confident about the return you will receive.
Your financial experience. If you don’t have a great deal of knowledge or experience in making investment decisions, then this might be an indicator that you should avoid higher risk investment strategies.
Your personal attitude to risk. We all have a personal attitude to risk which is subjective, sometimes difficult to measure and can change frequently.
How do I understand my attitude to risk?
Once we’ve understood your investment needs, we’ll ask you to answer some standard questions to help you and us understand your ‘risk profile’.
We use a simple scale of 1 to 5 to describe your attitude to risk, where 1 represents a more cautious approach to investments and 5 represents a more adventurous or higher attitude to risk
What do these risk categories mean?
1. Cautious
You are prepared to take a lower risk with your investment and so wish to avoid the risks usually associated with investing all your money in company shares. You are looking for an investment that is expected to be more stable and fluctuate in value far less than company shares and so is likely to involve a very high proportion of fixed interest assets. As a consequence, you accept that the investment return is likely to be much lower. You appreciate that over some periods of time the value of your investment can fall and you may get back less than you invest.
2. Moderately cautious
You are prepared to take moderate risks with your investment but wish to avoid the risks usually associated with investing all your money in company shares. You are looking for an investment that is expected to fluctuate in value less than company shares and so which is likely to involve a significant proportion of fixed interest assets. As a consequence, you accept that the investment return is likely to be lower. You appreciate that over some periods of time the value of your investment can fall and you may get back less than you invest.
3. Balanced
You are prepared to take a measured risk with your investment in return for the prospect of good longer term investment performance. While investing in company shares and property often gives the best potential for growth, you wish to limit the amount you invest in these areas. You are looking for an investment with the potential to produce good returns above inflation but with less fluctuation in value compared to company shares alone. You appreciate that over some periods of time the value of your investment will fall and you may get back less than you invest.
4. Moderately adventurous
You are prepared to take more risks with your investment in return for the prospect of better longer term investment performance. You are looking for an investment that has the potential to produce above average longer term returns, which is likely to involve a high proportion of worldwide company shares. You appreciate that over some periods of time there can be sharp falls, as well as rises, in the value of your investment and you may get back less than you invest.
5. Adventurous
You are prepared to take greater risks with your investment in return for the prospect of the highest longer term investment performance. You are looking for an investment that has the potential to produce superior longer term returns, which is likely to mean investing fully in worldwide company shares. You appreciate that over some periods of time there can be significant falls, as well as rises, in the value of your investment and you may get back less than you invest.
It is really important that any investment strategy is directly related to your attitude to risk and capacity for loss. This is to ensure that we put the right investment strategy in place for you, and that it meets your individual needs.
For example, if the questionnaire suggests a risk profile of 1 or 2 this indicates that your capacity for financial loss is very low or low. In this scenario, we may recommend a lower risk investment option. If your risk profile suggests an outcome of 4 or 5, or your capacity for loss is high, we may recommend higher risk investments.
Developing your investment strategy
Once we’ve understood your objectives, what investments you already have and your attitude to risk, we need to take account of:
• The type of assets and asset mix that best suit your risk profile.
• The most appropriate product to meet your financial objectives.
• The available investments that meet your needs.
What are asset classes and asset allocation?
Investment portfolios will contain one or more of the following. Some asset classes are higher risk and are more volatile than others. The percentage of each asset class you hold in your portfolio should reflect your attitude to risk, capacity for any loss and what you are seeking to achieve. Asset classes generally fall into:
Cash
These are the most stable types of investment, but returns can be lower than the rate of inflation.
Fixed interest
Funds that invest in this asset class usually invest in corporate and government bonds. The money you invest is loaned to a company or government, in return for which a fixed rate of return is provided. The loan is repaid in full along with the interest. These are generally considered relatively low risk investments.
Property
Funds that invest in this asset class typically invest in commercial properties like office buildings, warehouses or shopping centres. Commercial Property can take a significant length of time to be sold meaning you could be required to wait before you can get your money out of a property fund during which time its value could fall significantly.
Equities
Equities (sometimes called shares) are investments made into companies in the UK and abroad. Funds buy shares in different types of company / industry and regional sectors, depending on what their aims are. Some equities provide potential for capital growth, whilst others provide the potential for income returns. Equities can offer the potential for larger gains but are generally the riskiest of the four main asset types, since stock markets can have long periods of volatility.
The level of risk and potential growth provided by each of the assets is different, for example, historically equities have provided the highest levels of growth over the longer term, but also the highest level of risk, whereas fixed interest securities have provided lower levels of growth and smoother returns when compared to equities. We recognise that this is not easy to understand for most people! Our experienced, professional financial advisers will help you to understand what this all means for you and relate it directly to your personal goals and objectives.
How do I know what investments are right for me?
This will depend on your needs and objectives as well as your risk profile and appropriate asset allocation. Tax can also be an important factor. We will consider this as part of any recommendation we make to you.
Our Investment Process
Investment types and styles of investing
We’ll take the time to explain the advantages and disadvantages of each investment type. We’re committed to making sure the type and style of investment is suited to your individual objectives and risk profile.
For example, we’ll consider whether you would benefit from a growth or income strategy or if a ‘lifestyle’ type of investment might be more appropriate.
A ‘lifestyle’ investment is one that automatically changes its risk profile over time – for example automatically moving from a higher growth strategy to a lower risk capital protection strategy as you approach retirement.
What you know before you invest
Before investing, we want you to be aware:• Investment values can fall – you may get back less than you invest.• Investment income can fall.• Of the investment risks associated with each asset you invest in.
- Of the charges you’ll have to pay.
- Counterparty Risk. If a financial institution you invest with fails you could lose some or all of your money.
The performance of your investments affects the value of your account – we are not responsible for how any assets perform. Fund managers are responsible for fund performance and the performance of other assets will be affected by financial markets.
Warning: If you invest in these products you may lose some or all of the money you invest.
Warning: The value of your investment may go down as well as up.
Warning: These funds may be affected by changes in currency exchange rates.
