Nothing in life is without risk. We choose to take additional risk only if we believe we will be rewarded for doing so. Investing is no different. Your expected investment return is the financial reward you expect to receive for accepting a degree of investment risk.
So, what is investment risk?
Put simply, it is a measure of how much uncertainty there is about the return an investment may deliver. The more risk you take, the wider the range of potential outcomes. Taking additional risk can therefore lead to higher or lower actual returns than you would otherwise have achieved.
So you must balance your desire to receive a potentially greater return from a riskier investment with a lower return from a less risky investment. Your ability and willingness to accept risk will determine the suitable range of assets for your investment.
Understanding the risk associated with your investments is crucial. If you are not comfortable with or do not understand the risk you’re taking, you should not invest. Despite the promises of some investment products and funds, you cannot expect high returns without accepting a greater possibility of loss.
What’s more, no investment is risk-free, even bank deposits are potentially at risk. Many people choose to leave a significant sum in cash, oblivious to how inflation reduces its value over time. This strategy may lead to long-term financial disappointment.
Whatever your goals, we want to be sure that the investment strategy we recommend for you is in line with your attitude to investment risk. To establish your attitude to investment risk, we ask you a series of questions. Each answer produces a score and these are then aggregated to calculate your specific level of tolerance for risk, from 1 (low) to 10 (high). We call this your risk profile score.
Many of the terms commonly used to describe attitudes to investment, such as ‘cautious’, ‘balanced’ or ‘aggressive’ can mean different things to different people. That’s why we aim to make our assessment of your attitude to risk as objective as possible. And that’s why the next stage of the process is a discussion about what your risk profile score means.
Your resulting risk profile score is an indication of the extent to which you are prepared to accept a short-term fall in the value of your investments as markets go through their ups and downs. To do this we need to consider a number of factors. They include:
- The length of time you want your investment to last – its ‘term’
- Cash reserves you have available to meet the unexpected
- Your view on the potential for your earnings to grow
- How much money you want to invest
- Your debts
- Existing savings for retirement
- Your overall view on investing
- Your goals – do you really need to take on risk to achieve them?
- The impact of short-term falls in the value of your investments
- The importance of protecting your investment from inflation
- If you want to cash in your investments, how easy will it be to get your hands on your money?
These fluctuations in the value of investments are also known as their volatility. If your score is 1, then low volatility investments such as cash or bank deposits could be the resulting investment recommendation. If your score is 10, then we might recommend a portfolio which includes investments in asset classes such as emerging markets, whose higher expected volatility is matched by greater growth potential.
Before proceeding to make recommendations based on your score, we want to be sure that you understand what that score number means and what its implications are. We will tell you how investment gains and losses might differ between different risk levels, to give you a better idea of the outcome you could expect at each level.
In this way we can agree with you whether your risk rating accurately matches your true attitude to risk. Whatever the result of that initial discussion, we will carry out the same process each year at the annual review stage to ensure that your circumstances have not changed and that your attitude to risk remains the same.
Before you commit to any investment, we provide documentation that amplifies fully on your chosen investments and the risks that are peculiar to them in particular, and investing in general.