Home' Life from Fifty : May 2013 Contents Nobody has a crystal ball
But what is risk? In its simplest sense, risk is the variability of
returns. Investments with greater inherent risk must provide
higher expected yields if investors are to be attracted to them.
Risk can take many forms, including valuation risk (paying too
much for an asset), currency risk, exchange rate risk, market
risk, political risk and volatility. Assessing which investments
will perform well in future is much harder than looking at which
have done well in the past – nobody has a crystal ball.
Leading rather than following the herd
To make money from the stock market, for example, you need to
anticipate which companies everyone else will choose, and buy
them first. This means leading rather than following the herd.
When investment markets have fallen, it is human nature to shy
away, fearing further losses. Yet history has shown that this is
often the right time to buy. Likewise, when good news abounds
and markets are making progress, it’s easy to make the decision
to invest – yet the optimism at such times often means stock
prices are too high.
Don’t minimise the chance of achieving your goals
Risk is a fact of life for any investor. Thanks to inflation, there’s
even risk in doing nothing. To earn rewards you have to assume
some level of risk. If you minimise risk you may also minimise
your chance of achieving your goals. Understanding the level
of risk you are willing to take is crucial – a process known as
‘risk profiling’. This is essential as the more accurate your risk
profile, the greater the chance of selecting the most suitable
investments for your needs.
An important part of the risk profiling
Of course, your personal circumstances form
an important part of the risk profiling process.
Are you investing for retirement or looking
to save for a luxury holiday? Your age is also
important: if you are a young investor saving
for a pension, you may be more likely to take
higher levels of risk due to the greater length of
time to recover short-term losses. All types of
investment carry some risk of making a loss;
the main thing is to be comfortable that your
investments represent, as closely as possible,
a level of risk acceptable to you, and continue
to do so.
Helping you measure your appetite for risk more precisely
Historically, some of the measures of risk for various
investments have been somewhat broad-brushed. Many
investors have been categorised on three levels: ‘cautious’,
‘balanced’ or ‘aggressive’. There are now many sophisticated risk
profile questionnaires and online tools available to help you
measure your appetite for risk more precisely, with investment
strategies designed to match the outcome.
Increase your chance of better long-term returns
There’s no rule to say you have to have a diversified
portfolio, but investors who focus on one area will only be
right some of the time. Diversifying increases your chance of
better long-term returns. This includes choosing investments
across different asset classes (for example, shares, bonds
and commodities), geographical regions and also fund
management styles. Bear in mind that your portfolio can also
be too diversified. Too many investments and your portfolio will
tend towards the average and simply track the market.
Remember that over time, as your personal circumstances
and the economic outlook change, so too might your attitude to
risk. So it’s essential that you regularly review your investments
to make sure they continue to reflect your needs.
(Levels and bases of and reliefs from taxation are subject to legislative
change and their value depends on the individual circumstances of
the investor. The value of your investments can go down as well as up
and you may get back less than you invested)
Investing – Are you cheerful or fearful?
Is the world teeming with opportunity or full of danger right now? For shrewd investors, the answer is, of course, both – and
if you make the right calls, you can expect to profit. There’s no avoiding it: investing and risk go hand-in-hand. The truth is that
understanding risk is less risky than not investing at all.
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