How Comfortable are you with Risk?

Are you a risk taker or a risk avoider? How do you assess risk and make investment decisions?

The answers to these questions may be different from one person to the next, as risk tolerance is an individual trait which is formed throughout your life by a number of different influences.

The terms "Attitude to Risk" or "Risk Appetite" are often used to describe the level of risk you are willing to take when choosing which investments match your personality and financial objectives.

In order to identify and understand your risk appetite, it is important to know how much risk you can afford to take and what that actually means. It is also important to understand how your attitude towards risk can change over time as this will directly affect where you allocate capital.

Many people are scared to invest their money because they are afraid to lose it. I know that this is a common feeling but in this blog I will explain concepts which will help to remove some anxiety from investing your money.

What is Investment Risk?

"Investment Risk" can be defined as the likelihood of losing money relative to the expected returns, so the higher risk you are willing to take on, the more volatility you'll likely have to stomach.

As it stands, current interest rates offered by Savings Accounts are quite unappealing. Why? Well, the interest rates don’t even keep up with the rise in inflation (the general increase of prices within an economy over a period of time) and so deciding to invest your money gives it the chance to grow at a higher rate. It’s little wonder that many savers are looking for better returns elsewhere.

Now what needs to be understood is that risk and reward are inextricably linked. If you want to avoid volatility, you must also sacrifice potential rewards. That's how it is with investing, and it will always be true.

Your comfort with risk may be the most important factor in determining the right investment opportunities for you. The trick, then, is to find the appropriate balance between risk and reward. If there's one piece of advice that has served me well in life, it's this: Maintain a healthy respect for risk.

There's no way I can tell you what the right mix is for your investment portfolio. It depends on your personality, age, income, financial goals and tolerance for risk.

The Importance of Taking Risk

When we're young and just getting started, we know how important it is to be smart with our money. You work very hard with starting salaries and so feeling overprotective of any money is normal, however this often leads us to make choices that don't maximise our potential. We end up thinking of risk as a bad thing when it's actually essential to long-term financial success.

The word "risk" is thrown around a lot when it comes to investing, and it's often used as a negative term. This can be very intimidating for people who haven't had much experience with investing. However, what many people don't realise is that when they invest in the stock market they are actually reducing their risk in other areas of their life.

Investing allows you to reduce your exposure to things such as inflation; as inflation increases, your money loses value over time.

In order to take risks and make big decisions, here are 4 things I do:

1. Be sure they are calculated risks and won't leave you financially ruined if they don't work out.
2. Ensure you have the right resources at your disposal.
3. Be confident that your decision is the best possible one for you at this time in your life.
4. Realise that even if it doesn't work out, you'll have many more opportunities coming down the road.

Remember you don't have to dump it all in the market at once.

Historically speaking, the best returns in the long run are made by taking small steps on a consistent basis. This process is called Pound Cost Averaging. This is when you invest small amounts at the same time, each week or each month, into the same assets. You buy when markets are low and even when markets are high. What this does is reduce your overall risk to wild fluctuations and allows your portfolio to gradually capture growth over time.

Whilst the majority seem to think the most valuable asset we all own is money, the truth is that it’s actually time. When it comes to investing, truly wonderful things can happen if you’re willing to stay consistent with your actions over time.

Predicting short term outcomes is often difficult and it's easy to be pessimistic about our chances for success. However, when we look further into the future, we often forget that new variables can combine and compound to give us better results.

The first step in being a successful investor is learning to be patient. The second step is learning to be comfortable with risk.

How to Determine How Risky Each Asset Is?

Every investment can be described in terms of the amount of risk associated with it. Higher-risk investments tend to experience greater volatility, which means they are likely to go up and down in value more often and by larger amounts than lower-risk investments.

In return, higher-risk investments have the potential to produce higher returns over the long term, although this is not guaranteed. For example, investments such as cash deposits and bonds issued by the UK Government (known as gilts) are considered low risk.

Property, corporate bonds issued by UK companies as well as other types of global bonds issued by overseas governments and companies are considered medium risk. In the case of global bonds, generally those which pay a higher income are riskier than those which pay a lower income level.

Shares in companies in developed markets are considered high risk, while shares from companies in emerging markets are considered very high risk. You can reduce the overall risk in a portfolio by using ‘diversification’ – in other words, spreading your money across different investments.

By doing this, you can match your overall portfolio to the level of risk that is right for you. It’s important that your investment portfolio matches your willingness and ability to take investment risk.

Take Our Risk Questionnaire Now to Find Out How Comfortable You Are With Risk!

This questionnaire can help you to understand your attitude to risk, but has some limits:

• It is designed to help you make decisions for yourself, and shouldn't be considered as advice
• It doesn't take in to account how old you are, what your financial goals are or how much money you might be able to lose while investing
• It only covers risk, not your investment time horizon