There’s no escaping the fact that all types of investment involve some level of risk, although this can vary widely depending on exactly where you put your money.
If you choose a particularly high risk investment, such as cryptocurrencies, for example, you must be prepared to accept that you could lose all the money you put in. However, other types of investments, such as stocks and shares can also be extremely volatile, as demonstrated over recent months.
Stock markets in the UK and around the world plummeted following the threat of a new global banking crisis after Silicon Valley Bank collapsed, and although they have subsequently stabilised, periods of calm usually don’t last for long. Even if you’re invested in bonds, which are generally considered to be less volatile than shares over time, that doesn’t mean their performance won’t suffer during turbulent political and economic periods.
Whatever you invest in, you ideally need a timeframe of at least five years or preferably far longer, and you should consider your attitude to risk as part of the process of choosing which investments are suitable for you.
Here we explain how to decide on the level of risk you feel comfortable with.
How to work out your attitude to risk
You probably know whether you’re the type of person who generally takes a more cautious approach to saving and managing your finances, or if you’re happy to take some risks in pursuit of higher potential returns over the long term. After all, investing in the stock market may be your only chance of keeping pace with rising inflation, but you’ll need to be able to hold your nerve when markets face a bumpy ride, and accept that there are no guarantees how your investments will perform.
If you’re not quite sure how much risk you’re comfortable with, though, think about how you might feel seeing your investments plummet in value, and the impact this might have on your emotional wellbeing, as well as your overall financial situation. Investing isn’t for the faint-hearted, as the stock market can be unpredictable.
Only you can know what level of risk you’re truly comfortable with, but you should think about whether you can afford to lose money or tie it up for many years in the stock market. If you do not want to risk losing any money, and you’re worried about having enough cash set aside to meet rising living costs, investing isn’t likely to be right for you. Bear in mind, though, that even cash savings accounts aren’t without risk as inflation can eat into the purchasing power of your money over time. Read more about investing in our article Is investing right for you?
Consider your timeframe
You need a sufficiently long time horizon before investing, so that your investments have time to ride out stock market highs and lows. It’s particularly important to remember this at a time when there are a number of threats to the potential for stock market returns and your personal finances, including rising interest rates, a cost of living crisis and uncertain geopolitical outlook.
However, if you’re investing in a pension that you don’t plan to touch for decades, you can probably take more risk with your investments than if you need the money in five years’ time, for example. Your timeframe has a huge impact on which assets you choose to invest in. You can read more about the different types of investments you can choose from in our guide Investing – the basics.
Ultimately, your tolerance for risk is linked to your investment timeframe, and the longer you have, the more you may be prepared to stomach short-term losses as hopefully your investments will have time to recover their value over time.
Remember that stock markets will always have bad years as well as good ones, and the longer you stay invested, the more time your money has to bounce back from downturns. Although there are no guarantees, the stock market has recovered from a series of crises, such as the dotcom bubble, global financial crisis and covid-19 pandemic, even though a comeback may have seemed unlikely at the time.
Decide what you can afford to lose
All investments carry some risk, so whatever you do, don’t invest more than you can afford to lose. Ideally, you should keep cash savings of around three to six months’ worth of expenditure set aside to cover any emergencies, such as a boiler breakdown or car repairs. Find out more about the different ways you might be able to do this in our guide How to build an emergency cash buffer.
How to reduce risk
Some investments are considered riskier than others, and generally, spreading your investments between different companies, types of assets and geographic areas can help to smooth returns over time. This way, you avoid putting all your eggs in one basket, which is one of the golden rules to successful investing.
There will always be some investments that perform better during difficult economic periods than others. For example, gold is considered a traditional safe haven asset during turbulent periods, and it has soared in value over recent weeks following the outbreak of a war in Europe and rising inflation. Read more in our article Five facts about investing in gold. However, gold itself is very volatile, and there are no guarantees it’ll continue to perform strongly.
One way to spread risk is to put your money into a fund, for example, rather than investing in individual shares or a single asset. This way, you can hold dozens of companies and spread risk. Your money is pooled together with other investors’ cash and spread across a range of companies and, sometimes, other assets. So if one company or asset performs poorly, the hope is that gains made by others will reduce overall losses.
In particular, a multi-asset fund may be an option worth considering if you’re choosing a single investment, as these hold companies around the world in a single fund. There are plenty to choose from, with options for cautious and more adventurous investors. If you’re nervous about investing, look for a multi-asset fund that also holds cash and gold to reduce risk.
Drip-feeding money into funds by investing, say, £50 or £100 a month instead of a lump sum, can also help to reduce risk. You benefit from what’s known as ‘pound-cost averaging’ as you buy more shares when prices are low, and fewer when they are higher, which can help to smooth out stock market volatility.
If you’re worried about stock market volatility affecting your investments, you may find our article Four ways to weather stock market storms useful.
Where to go for more help
It can be difficult knowing where to start when it comes to assessing your risk, particularly during such uncertain times when you may already be feeling anxious.
If you want further help before investing in an ISA, for example, or towards retirement, a financial advisor can help you work out your attitude to risk if you’re unsure, or if you have a large amount to invest and want tailored advice.
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