There are various different risks and it is important, that before investing, you are aware of the different types and the affect they can have upon your investments. Details are provided below of the main types of risk that might affect your investment decisions.
The risk that the buying power of your capital decreases over time.
This is inflation risk. It is a risk that capital won’t grow fast enough and therefore, won’t keep pace with inflation and won’t retain its buying power. “Safe” investments such as bank and building society accounts, fixed return contracts and National Savings are all exposed to inflationary risk. For example, if inflation was 3% at the start of the year, and the return on a fixed rate building society account was 3%, your money would keep pace with inflation, however, if the inflation rate moved up to 5% your investment would not be holding its value.
Most things go up in cost, particularly when inflation is high, for example, in simple terms and using the rates of 3% and 5% above, a holiday might cost £1,000 today, but due to inflation, the same holiday a couple of years later could well be £1,100, but the capital in your bank account would only have grown to £1,060. This example also assumes you left your money in the building society to grow, if you had taken a monthly or annual income then it would still only be worth £1,000.
The risk that you lose all your money.
It can and does happen, although relatively rare. With some types of investments you can actually lose all your investment and be liable for more! Generally speaking very high risk investments like these would only be recommended to professional investors, they are usually known as futures, options, unquoted stock or unregulated investments.
However, it is also possible that an investment that has been marketed and sold as a cautious, conservative or guaranteed investment, returns nothing. It is important to remember that it is possible for the institution responsible to become insolvent.
It is also possible to lose a high proportion of capital if invested in riskier Markets as well as riskier product types. For example, investing in healthcare or technology funds, or perhaps Far Eastern Markets could result in heavy losses – as well has the possibility of large profits.
The risk that the growth your capital experiences is variable.
This simply means that the return or growth on your capital could be volatile, it could go up and down quite erratically and possibly, dramatically! This is generally why, any investment with an element of risk or volatility should be held for a minimum term of 5 years, usually longer. Investing in a fund or a spread of different investments will also help iron out some volatility. Usually, the longer the term and the better the spread the less the volatility
The risk that you might get back less than you invested.
This is always a risk with investments that are linked to stockmarkets, and in fact to many other types of investment. There are very few investments that don’t incorporate this risk. Even your own house can be a victim of this type of risk, so can the money you buy to go on holiday – you may pay a certain amount for your foreign currency when you go but get a lot less when you come back and want to change it back into Sterling!
What you need to consider is how much you can afford to risk or afford to lose, this is something you should discuss with your adviser. It is important to consider not just the risk you are prepared to take but the loss you are able to sustain.
The risk that you do not achieve your objectives.
This could for example be that you are saving within a pension plan and it doesn’t produce the annual pension you had hoped for when you retire. You may be saving in a building society account to buy a holiday home, but find your capital hasn’t kept up with inflation and you won’t be able to afford it. Or you could be hoping for a specific amount of regular income from your investments, and may not be able to achieve this. There are many things that pose a risk to you not achieving your objectives, which is why professional advice should be sought and reviews of your investments and objectives carried out.
There are other risks such as exchange rates, interest rates, political and industrial change, fraud and natural disasters all of which can affect the various different types of investment. There is also the risk posed by not seeking professional independent advice, advisers have the knowledge and experience to make quite a difference. They will be aware of the type of schemes you should steer clear of, they are able to discuss your needs and attitude to risk with you, are aware of the frequent changes that occur within the Market place, taxation implications, and can answer any questions you may have.
Unless you are adamant you want no loss of capital whatsoever and are aware of inflationary risks, generally speaking, the best thing to combat all the varying risks is to balance and diversify. This means spread capital around into different areas and different types of investment, what amount goes where will depend upon how you feel about risk and the amount you are able to lose – again, this is why you need to discuss your requirements with your adviser.
There will of course be people that want to stick to one type of investment, for example, Stockmarket linked investments, however, it’s important to remember those who only invest in one type of investment or area, whatever it might be, will only be right some of the time!