Understanding your attitude to risk

Posted on May 22nd, 2020 | Categories - News

A report last year confirmed that only 6% of UK investors are risk-takers. 56% of those questioned said their risk appetite was either low or zero, with 26% saying that their attitude to risk was based on the fear of making a wrong investment.

But what informs your attitude to risk? Can your risk profile change over time? And what effect might risk aversion have on your finances?

What is risk?

When we talk about savings and investment risk, we can mean several things.

There is the risk that an institution will fail, that your savings will not keep up with inflation, or that your investment will result in a loss of capital. There’s also the worry that you could have earned better returns elsewhere.

When you’re deciding where to put your money, it is generally hoped that higher-risk investments will bring higher rewards, but potential growth comes with its associated perils.

Your attitude to risk should be informed by your long-term goals – how much money you would like to have by a certain point – as well as how much you can afford to lose.

What can affect your attitude to risk?

Your attitude to risk is likely to fluctuate. If you inherit a large sum of money you might become suddenly less risk-averse. Conversely, if you’re starting a family, you’ll need to think about your financial security in relation to your child’s future too.

Broadly your attitude to risk is based on:

  • Your capacity for loss

It’s important to know how much you can afford to lose. By investing only the money you can afford to lose – or at least the money you know you don’t need in the medium term – you reduce the pressure on that investment to do well.

Ask yourself: What impact would a financial loss have?

This might not be an optimistic way to approach the market but your capacity for loss is a crucial part of understanding your risk level.

  • The length and purpose of your investment

If you’re saving for a car or a house deposit and you plan to spend the money in the next few years, investing in a high-risk fund might not be right for you.

Short-term investments have a short amount of time in which to recover from volatility and could mean selling at a loss.

Long-term investments, on the other hand, could see sustained periods of growth between short, sharp shocks to the market. A long-term investment has longer to recover from momentary blips and as you aren’t constrained by needing the money in the short term you can afford to be patient, riding market storms.

The cost of risk aversion

You might have cash savings but with the Bank of England base rate at a record low of 0.1% they won’t be earning you much interest.

Take into account the rising cost of living and inflation means that your savings may be losing value in real terms.

Yet it is also true that the general trend of the stock market is an upward one. You might find that a small amount of investment risk is essential – not for growing your current wealth, but simply to maintain it.

What is the ‘right’ amount of risk to take?

Your attitude to risk is personal to you and, as we have seen, it isn’t necessarily a static thing. Changing circumstances can change your risk profile and that means one size certainly doesn’t fit all.

If you are only looking to use your investment to combat the effects of inflation, a low-risk investment will be exactly what you need.

You might decide, depending on the factors already addressed – how much you can afford to lose and the length of time before the funds are needed – that the additional risk is worth it when weighed against the potential for higher returns.

The benefit of seeking advice

Your attitude to risk is personal to you but that doesn’t mean you can’t benefit from professional financial advice.

As advisers, it is our job to get to know you, your circumstances and your attitude to risk, putting together a long-term financial plan that delivers on your goals and aspirations for the future, whatever they might be and irrespective of your risk profile.

Get in touch

If you’d like to discuss your attitude to risk or any aspect of your long-term investments, get in touch. Please email info@investmentsense.co.uk or call 0115 933 8433.

Please note:

The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be regarded over the longer term and should fit in with your overall attitude to risk and financial circumstances.

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