When we hear the word “risk”, we automatically think of something negative. Combine that in a sentence with, “your money”, and in under five seconds your mind has taken you from a retirement sipping cocktails on a sandy beach to working three jobs until your body gives up. It’s an emotional rollercoaster.
In finance, risk is a very personal thing. Your attitude to risk, and your capacity or need for risk, are completely dependent on your circumstances. And like your circumstances, it’s probably not going to stay the same throughout your life. So how do you decide what’s worth the risk?
What is risk?
There are a variety of risks when it comes to saving and investing; here’s a few of the risk types involved:
- Market Risk: the risk associated with fluctuation of market prices
- Inflation Risk: the risk of money not keeping up with inflation rates
- Interest Rate Risk: the impact of changes in interest rates on the value of an investment
- Liquidity Risk: the risk of being unable to transact when necessary due to lack of access to liquid funds
- Default Risk: the risk that an institution will fail
This list isn’t exhaustive; there are plenty of other risks when it comes to investing, such as political risk, geopolitical risk, technology risk, and environmental risk. If you’re thinking it’s all starting to sound a little complex, you’re not alone. No wonder the word “risk” has us all feeling a little jittery.
Am I feeling risky?
When you understand what risk is, and you are receiving financial advice from an adviser you feel comfortable with, you’ll start to feel better about the whole concept, and maybe even realise it’s not so scary after all.
There are four key things you need to have an understanding of when it comes to risk and your money.
- Your capacity for risk
In other words, how much could you afford to lose? This might seem like a no-brainer, because no one wants to lose money, but it’s crucial to understand what the impact of a negative outcome might be.
- Your goals and timeframes
It’s really important to establish what you want to achieve, when you want to achieve it by, and therefore how much risk you would need to take to make this achievable.
- Your attitude to risk
This is how you feel about taking a risk. You need to be comfortable with the risk you are taking, and a better understanding teamed with an adviser that has your confidence will help your capacity, goals and attitude align.
- The need to take risk
Do you need to take a risk in the first place, what is the purpose of taking a risk for higher returns if you already have all the assets you need?
Why risk it?
You may be wondering why, even if you have the capacity for risk, you would be taking any risk at all? In fact, there’s a risk attached to everything. You might think that holding every penny you have in cash savings accounts means you’re not risking a thing, but since traditionally cash has a relatively poor return on investment, one of the risks you’re running here is that your money is losing value because of inflation. You might start with £100,000, and still have £100,000 in ten years’ time, but in ten years’ time £100,000 might only be worth today’s equivalent of £75,000. So, in reality, risk is everywhere when it comes to your finances, and that’s why it’s such an important topic to understand.
NB: The value of the investment can go down as well as up and you may not get back as much as you put in.