Assessment of risk is vital in developing any investment, saving and protection strategy. Usually, the higher the projected return, the higher the potential risk and the lower the risk, the lower the potential for reward.
Your attitude to risk may well be formed by your attitude to the following:
1. Inflation
Over time, rising prices reduce the buying power of your money. This is especially a problem where income is paid out to you, so the real value of your capital falls. Reducing inflation risk usually means taking on some capital risk.
2. Interest Rates
Variable interest rates can fall (bad for savers) or rise (good for borrowers). Fixed rates lock you in so if other interest rates rise, a fixed rate is bad for savers, but good for borrowers. If other interest rates fall, a fixed rate is good for savers, but bad for borrowers. Will interest rates rise or fall in the medium to long term and what will happen to global interest rates?
3. Shortfall Risk
Shortfall risk relates to your financial goal. You may be saving or investing money in order to reach a target amount at some time in the future. You may aim to pay off a debt, loan or mortgage, or aim to build up a particular level of retirement income.
If you choose investments with no or low risk, your returns are likely to be lower and could fall short of the amount of money you want to target - shortfall risk. This means you may have to choose whether to change the target amount you want to obtain, increase the amount you save or invest, or save or invest for a long term.
4. Capital Risk
The possibility that you will lose some of the money you invested originally. Stock market fluctuation is one example of capital risk - the value of investments linked to the Stock Market can vary. This means, that although the long-term trend tends to be upwards, at any particular time the market might have dipped, so your investment could be worth less than you had paid. You may need to accept some capital risk to offset shortfall risk and inflation risk.
5. Market Risks
Are market valuations realistic? What is happening to economic and business activity?
6. Exchange Rate Risk
Is there an overseas dimension to the investment?
7. Political Risk
Is an impending general election likely to affect performance? What would be the implications of terrorist acts on the performance of the investment?
8. Investment Timescale
A shorter timescale tends to increase the risk. How long you want to invest for, has an effect on where you should invest your money.
9. Age
As you get older, you may be less willing to take capital risks because you cannot replace easily any money you lose through earnings.
10. Family Commitments
You may be reluctant to take capital risks if family members could suffer as a result. You may need to protect your family against inflation risk (for example, index-linked life cover and income protection insurance).
11. Income or Assets
The less you have, the less you can afford to take capital risks. You may be more inclined to choose a low risk investment or a fixed rate cash deposit.
What is your attitude to risk?
As an investor it is important that you are fully aware of investment risk. Your financial adviser needs to understand your attitude to risk as this will help provide you with suitable recommendations that are tailored to meet your specific needs and objectives. See below for five investment categories. These are simply guides because fund values will normally fall and rise in line with movements in the investment markets. You should review your fund choice regularly to ensure it is still meeting your objectives.
| Definitions of investment periods | Short term (less than 5 years) | Medium term (5-10 years) | Long term (over 10 years) |
| Very Cautious Risk 1 | I am not willing to accept any risk to my investment in the short term and want to invest wholly in cash assets. I understand that the potential for growth is small and that over the long term inflation will reduce the buying power of cash assets. I also accept that interest returns from deposit based investments may move up and down, sometimes quite suddenly and there may, therefore, be no security as to levels of income arising. |
| Cautious Risk 2 | I am looking for an investment where the return over the medium to long term is expected to be an improvement on that available from high street deposit accounts. I understand that this will increase the amount by which my investment will fall and rise in value and therefore I could get back less than I invest. I would consider investing in cash, fixed interest investments, stocks and shares and/or property markets. My aim is to at least maintain the real buying power of my money as compared with inflation over the medium to longer term. |
| Balanced Risk 3 | I am looking for a balance of risk and reward with the aim that, in the medium to long term, higher returns may result than those available from more cautious investments. I am willing to accept that the value of my investment will fall and rise in value. I could get back less than I invest. I accept that a significant proportion of my funds will be placed in stocks and shares. Risks will usually be reduced by spreading investment across a variety of sectors and markets and/or limiting exposure to overseas markets. My aim is to improve the real buying power of my money, as compared with inflation, over the medium to longer term. |
| Adventurous Risk 4 | I am willing to accept a high level of risk on my investment in order to seek higher growth potential in the medium to long term than is available on less speculative investments. I am prepared to accept that this will increase the risk of large fluctuations in the value of my investment and of losing some or possibly all of my capital. I could get back less than I invest. I would consider investing in a narrow range of asset classes, primarily in stocks and shares and there may also be exposure to currency and political risks via investment in overseas markets. My aim is to improve the real buying power of my money, as compared with inflation, over my selected investment return. |
| Very Adventurous Risk 5 | I am willing to accept a very high level of risk on my investment in order to seek very high growth potential in the medium to long term. I am willing to accept sharp day-to-day fluctuations in the value of my investments and the risk of losing some or all of my capital. I would consider investing in specialist stocks and shares markets or sectors which are expected to be particularly volatile e.g. Emerging Markets. There will be exposure to currency and political risks via significant investment in overseas markets. I could get back less than I invest. I also appreciate that certain high-risk investments may not be easily realisable, as there may not be a ready market for the sale of such investments at the required time and that it may be difficult to obtain reliable data for valuing such investments. My aim is to improve substantially the real buying power of my money as compared with inflation over my selected investment term. |