Risk is an important component of any financial plan and will ultimately influence the outcome of any investment.
Risk is defined in financial terms as the chance that an outcome or investment's actual gains will differ from an expected outcome or return. Risk includes the possibility of losing some or all of an original investment. *
Risk is not necessarily a bad thing when investing, if used correctly. Risk is determined by the careful study of the history and performance of various funds over many years. This then will classify the funds into various risk categories.
An investor can choose the correct risk category according to their risk profile and savings goals. e.g. an older investor nearing retirement would potentially prefer a lower risk investment that preserves their capital because they do not have time for any volatility to even out. A younger investor has time on their side and can choose higher risk investments that will even out volatility over time.
The higher the risk, the bigger the potential losses but also the bigger the potential returns.
Types of Risk
Risk is generally divided into 5 types of levels:
Cautious – ideal for clients who want as little risk as possible. They want to preserve their capital and aim for lower returns in exchange for security
Conservative – ideal for clients who still want low risk investments but are willing to risk potentially higher returns
Moderate/Balanced – ideal for clients who are saving long term and willing to take more risk to receive better returns knowing the market will balance out any fluctuations over time. They tend to have a balance of equites, cash, and bonds
Moderate Aggressive - Ideal for clients willing to take high levels of risk with the goal of receiving higher returns over time. The percentage of equities is much higher than cash and bonds
Aggressive – These clients are aiming for the highest returns and accept that their investment value could fluctuate significantly between profit and loss but know that time will even out volatility. Equities/stocks tend to dominate their investment choices
Ways to manage risk
High risk investments do not necessarily result in high losses. There are ways to mitigate risk.
- The length of an investment could determine the risk level.
Generally, higher risk investments are better over the long term, as time allows for the volatility of the markets to even out. Just as low-risk investments are more conducive to short term savings and offer lower but more stable returns.
- Mixed asset classes could lower risk.
There are different kinds of asset classes. Equities are higher risk, but offer the potential of higher returns, whilst cash and bonds are generally more stable and could offer lower returns. A mix of all asset classes could lower your risk and chances of loss.
- Diversification lowers risk
Dividing your investments over various regions and different sectors e.g. US, Europe, Asia, financial, energy, technology, property etc. could lower your risk as you are dividing the risk of loss as not all regions and sectors are affected by others simultaneously.
It’s the case of carrying your eggs in different baskets so if one basket breaks, the others are still safe. Not all regions and sectors are affected by others simultaneously. *
It is important to chat with your adviser to determine your risk profile and your investment goals so you can make the right investment choices at the right risk level. [email protected]
* https://www.investopedia.com/
Please note, the above is for education purposes only and does not constitute advice. You should always contact your deVere adviser for a personal consultation.
* No liability can be accepted for any actions taken or refrained from being taken, as a result of reading the above.