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Investment risk – how risky is your portfolio?

We look at why taking more risk with your investments doesn’t always pay off, and how to spread risk across your portfolio.

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.

Whether you’re new to investing or have been doing it for decades, managing risk is one of the key investment principles.

Finding the right balance between risk and reward can be tricky. If you take too much risk, you could leave yourself exposed to big drops in your portfolio. Not taking enough risk could mean your investments don’t grow quickly enough to meet your financial goals.

This article gives you information to help choose the right level of risk for you, but it isn’t personal advice. If you need help with this or if you're not sure an investment is right for you, we have experienced financial advisers who can help.

High risk, high reward?

Risk is a certainty when investing. All investments carry a degree of risk – some more than others.

Risk is the idea that your investments could fall in value and not rise again, leaving you with less than you invested. In day-to-day investing, we usually define risk as how often and sharply prices swing, also known as volatility.

Higher-risk investments can make particularly painful viewing when stock markets take a turn, especially if the investment doesn’t match how much risk you’re happy taking.

FTSE 100 vs FTSE 250 - Financial Crisis 2008

Past performance isn’t a guide to future returns. Source: Lipper IM to 31 December 2009.

We saw this play out during the financial crisis in 2008 when the FTSE 250 plummeted at a sharper rate than its larger counterpart – the FTSE 100. As the FTSE 250 is the biggest 250 companies after the FTSE 100, the companies are smaller and higher risk which adds volatility.

But if you’re able to sit tight and ride out the market waves that come with higher-risk investments, you could be rewarded. In most cases, the more risk you’re prepared to take, the higher the potential profit although of course there are no guarantees.

The graph below shows how the FTSE 250 has outperformed the FTSE 100 over the long term – offering a profitable reward for those investors willing to take more risk.

FTSE 100 vs FTSE 250 (2000-2020)

Past performance isn’t a guide to future returns. Source: Lipper IM to 31 December 2020.

No reward is guaranteed

The relationship between risk and reward doesn’t always hold true. Higher expected returns are only expected – not guaranteed – and not all risks are rewarded. As investments become more speculative, the chances investors could lose money becomes greater.

In fact, the FTSE AIM index – which is a combination of the most high-risk, smallest listed UK companies – has performed the worst out of all the main indices over the last 20 years*.

UK Stock Market Performance (2000-2020)

Past performance isn’t a guide to future returns. Source: *Lipper IM to 31 December 2020.

Could you be better off holding investments which offer less, but hopefully more reliable returns? While it’s somewhat less adventurous, taking a long-term view and diversifying your portfolio across larger and more established businesses is often a better choice for investors.

“If you don’t feel comfortable owning a stock for 10 years, you shouldn’t own it for 10 minutes” – Warren Buffett.

All investments can fall as well as rise in value so investors could make a loss. Past performance isn’t a guide to future returns.

Why you should think twice before buying ‘hot’ stocks

Maximise returns with a core-satellite strategy

Hand-picking a mix of different investments to match your attitude to risk and investment goals can be tricky, even for the most seasoned stock pickers.

While there’s no one-size-fits-all approach, we think a core-satellite strategy is great for lots of investors.

The core is your main group of investments – a mix of investment types that match your risk profile. This should be the bulk of your portfolio. Usually a sensible mix of funds .

A fund is a collection of investments, chosen and run by the fund manager who’s trying to achieve the fund’s investment objective. An active fund will try to beat the performance of the fund’s benchmark. A passive fund (tracker) will try to track the performance of the fund’s benchmark as closely as possible. Funds come in all shapes and sizes so it’s easy to build your own portfolio to suit your goals and risk profile.

Mixed investment funds can be a great way to spread your money across lots of shares, bonds and money markets – helping you achieve greater returns with a relatively lower-level of risk. For investors searching for added risk, small and mid-sized companies funds can offer you an adventurous, but high-risk, way to grow your wealth.

Your core investments could be surrounded by smaller satellites. These can be made up of shares in individual companies that you think might perform well over the long term. Make sure you understand the companies you’re choosing. If the company fails, you risk losing your whole investment.

Although individual shares carry more risk, holding them as a small part of a bigger portfolio reduces the overall impact if they do perform badly.

If you’re happy to build your own portfolio but just need some fund ideas, you could take a look at our Five funds for 2021 or our Wealth Shortlist.

Investing in funds isn’t right for everyone. Remember, funds are investments that can go down as well as up in value, so you could still get less than you put in.

Key points for managing risk

  • Own a mixture of different investment types (shares, bonds and funds)
  • Adjust how much you have invested in shares and bonds based on your tolerance to risk
  • Always own investments with a long-term view – at least 5 years

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    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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