Understanding investment risk

Esther Shaw / 16 November 2015

If you’re thinking about investing – or already investing – it is essential that you understand investment risk, as this is one of the basic tenets of all financial planning.



When you think about “risk” you might think about the possibility of not getting all your money back.

But what exactly does it mean in an investment context?

Don't fall into the investment traps! Read Annie Shaw's guide to common mistakes.

What is investment risk?

Investment risk refers to the chance that the actual return you get on an investment will be different from the earnings or outcome that you expected.

This includes the possibility of losing some – or all – of your original investment.

Levels of risk

Risk also measures the uncertainty that an investor is willing to take to realise a gain from an investment.

Investments can go down as well as up, and these movements can depend on the assets you’re invested in – and how the markets are performing.

Put simply, the greater the return you want, the more risk you will usually have to accept.

Equally, the more risk your take with your investments, the greater the chance of losing some of your original investment (capital).

Confused by all the investment jargon? Read our simple guide.

Identify your attitude to risk

As an investor, you need to be objective about how much risk you are prepared to take within the context of your financial goals and your investment time-frame.

Younger investors may feel comfortable investing in assets with a higher potential for growth but greater risk, because they have plenty of time to benefit from long-term growth.

By contrast, if you’re nearing retirement, you should look to choose more conservative investments which are steadier in both risk and return.

Download Saga Investment Services' free fact sheet to find out more about investment risk and what it could mean for you.

Different assets and risks

When thinking about your attitude to risk, a useful starting point involves getting to know the risks associated with the various different asset classes that you can invest in.

The four main types are cash, bonds, property and shares.

Cash

Cash is the least risky of the four asset groups and the most secure way to invest.

The problem is, cash tends to deliver the lowest returns; if the rate you earn on your cash is below the rate of inflation, the value of your money will be eroded over time.

Bonds

As an investor, you can buy bonds from companies (corporate bonds) or the government (gilts).  A bond is a loan, with you as the lender. In exchange, you get a fixed rate of interest.

Bonds are popular among investors, as they are safer than shares. On the downside, you stand to gain less than with equities.

Property

There are lots of ways to invest in property, including buying your own home and purchasing a buy-to-let property. You can also invest in property funds, rather than buy your own.

Equities

Investing in equities – or shares – means buying a stake in one or more companies.

Based on historical trends, shares can offer the highest returns. But at the same time, they are the most risky asset class – and much more volatile than bonds. If a company does worse than the market expects, your shares can fall dramatically in value.

While you might get back more than you invested if you wait long enough, there’s a chance that when you want to sell, you will have to sell at a loss.

Not sure how to start investing? Read our beginners' guide.

Risk and time-scale

If you are investing over the short-term, it is not wise to take on too much risk, and you should look to keep most of your money in cash.

But if you are investing for the longer-term, you can afford to take more risks, as your money has time to recover from the peaks and troughs of the stock market.

Equally, for many cautious investors, not taking enough risk can become a risky strategy in itself, as while you may not lose money, you may not make enough to achieve your financial goals.

Download Saga Investment Services' free fact sheet to find out more about investment risk and what it could mean for you.

The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.