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  • Risk: what you need to know

    Risk is a certainty in investing. You can’t get rid of it, but you can manage it. To understand the potential of you losing money, versus the potential of you making it, there are two main factors in your control:

    • How well you’ve diversified your investments
    • Understanding how much of investing is based on human psychology

    Read on to understand more about how much risk could be right for you.

    Risk: what you need to know

    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

    What is risk?

    Imagine you're going on holiday. You know they’re expensive, and not technically necessary. But they give you experiences you don’t get at home – whether it’s breath-taking scenery, exciting activities, or just having someone else do the washing up.

    If you think it’s worth it, you’ll pay for the reward of a good time, and good memories. But there’s always a risk it won’t turn out so well. The airline could lose your luggage, your hotel might not look like the pictures, or you might not see any animals on safari.

    So you might not want to risk your money. You can always choose to stay at home. That’s a bit like holding cash. It’s relatively safe, but it’s also unspectacular. You get what you pay for.

    In the investing world, ‘risk’ is the price of an experience you can’t get anywhere else - growth you won’t get from cash in a bank account. The price is uncertainty, and patience.

    Investments will rise and fall in value.

    But risk isn’t your investments falling. It’s the idea that they might not rise again or you might get back less than you invest.

    Investments go down - that’s their price. But over the long term they could go up, and as long as you’re willing to pay the price of patience in the short term, we know that many investments have paid investors back over the long term. It’s never a certainty, and depending on the investment, it can be a bumpy ride. Taking on more risk could give you more reward – but bigger losses.

    Past performance isn't a guide to the future. Before choosing an investment, please check you’re happy with the risks.

    What does risk look like?

    On a basic level, different investments carry different levels of risk.

    Investments which have a higher chance of returns are likely to give you a bumpier ride along the way. Lower-risk investments tend to be steadier, though in general you can’t expect as much of a return.

    You can’t rely on one type of investment to give you the returns you need. To reduce the ups and downs, the best way is to spread your assets.

    Below you can see some examples of what a portfolio might look like at different risk levels – in its best and worst years. It’s just a guide to illustrate a point, and not an indication of how you should invest.

    Important: you should look at how much the portfolios at certain levels of risk have gone down in value in the past, and ask yourself how you’d feel if it happened to you.

    What’s in the portfolio? Best calendar year return % Worst calendar year return % Biggest loss
    Cash 100% cash 4%
    2006
    0.3%
    2017
    0%
    Lower Risk 70% bonds

    20% UK shares

    10% global shares
    18.6%
    1998
    -1.8%
    2001
    -7.75%
    Medium Risk 40% bonds

    30% UK shares

    30% global shares
    18.9%
    1997
    -11.8%
    2002
    -24.42%
    High Risk 0% bonds

    50% UK shares

    50% global shares
    27.6%
    1999
    -24.8%
    2008
    -45.56%

    Past performance is not a guide to the future. Source: Lipper IM 1997-2019

    How much risk is right?

    Risk is personal.

    It depends on a number of factors – what you can afford to lose, what you want to gain, and how you feel when you’re investing. This is just a guide to understanding risk – it doesn’t cover everything, and it’s not personal advice. It’s important to base your decisions on your personal circumstances. If you’re not sure what the right decision is for you, you should seek advice.

    • If you have more time (or if your timeline isn't fixed), you could consider taking on more risk. If you don’t choose risky enough investments, you might not get to your goal, but you also need to be prepared for the rises and falls in value that come with investing.
    • But if you're starting your investing journey later, you have less room for unexpected dips – so lower risk investments could be better.
    • How you feel when your investments go up and down will have an impact on the decisions you make. The difficulty is knowing how comfortable you are with what you might lose or gain.

    Risk can be an opportunity, not a negative

    You can only earn better returns by taking on more risk. It’s as close to a law as you’ll get in investing.

    But it won’t be a smooth ride of upwards growth. Your portfolio will definitely go up and down along the way. Sometimes, these ups and downs will be big. It’s how many of the ups and downs you’re happy to deal with which is your attitude to risk.

    Being realistic about what you’re expecting to gain might help you work out the kind of risk you’d have to take on to get there. If you’re not happy with both the gains and the potential ups and downs, then you might have to adjust your expectations.

    Think back to your holiday. You might have got sunburnt, or bitten by mosquitoes – but did the good memories outweigh the bad ones?

    How do I manage risk?

    Room for error is the only way to navigate a world that is impossible to predict

    MORGAN HOUSEL

    In investing, you can make room for error by diversifying your investments. So when one investment goes through a bad patch, hopefully, there will be others which are doing well.

    And you need to set aside enough cash for emergencies. We usually suggest 3-6 months expenditure is a good starting point.

    What you can control

    • How well you’ve diversified your portfolio.

    Diversification is a tool to help you manage risk, when you have no way of knowing what’s going to happen.

    • How you react to news, and the decisions you make.

    What you can't control

    • Short-term noise, and what’s going on in the news.

    What’s going on around us causes us to make decisions – but it doesn’t mean they’re the right ones for your personal goals.

    • How your investments perform.

    Three things to help with risk

    • Time is on your side. Investing is for the long term. If you take your money out when you see it drop, you risk buying investments back at the wrong times, and you’ll undo the good work you’ve already done building your investing base. It’s called compounding.
    • How you behave and react is a big part of understanding risk. Understand that the right decision might seem counter-intuitive.
    • You can’t predict, you can only prepare. Diversification is in your control.

    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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