The following article is a guest post from our friends at Nutmeg, the UK’s largest digital wealth manager. Money Dashboard users get 9 months fee free investing when they open a Nutmeg account. More info here. Capital at risk.
In investment, as in life, it is easy to encounter risky situations where you can lose out. Here we go through the nature of risk and how you can minimise it when it comes to investing.
Investing can be seen as a form of risk management, seeking the returns you want against the risk you are willing to take.
1. What is risk and why do some find it attractive?
Risk is not the most inviting of propositions but when looking at risk in terms of investing, fear needn’t be a factor. Truly understanding risk as a concept is simply a cornerstone of successful long-term investment management.
Risk describes the uncertainty of the returns on an investment. It is an indicator of the potential for losing money and making money. Although we often do not think of it this way, it can mean returns could be unexpectedly high – although with a higher chance that you could lose more too.
Different investments will be more or less risky. Shares are considered riskier than bonds, although this is not true for individual shares and bonds. Investments that are more likely to give higher returns in the long run may have a bumpier ride along the way, whereas investments with a lower return potential are often more likely to remain steady and stable for the duration.
Put simply, investments that have higher risk usually have higher rates of return. So, individuals who are looking to increase the value of their investments significantly, and who are prepared to accept that the value of their investments might fall, are more likely to choose to invest in assets that have higher risk.
No single asset class can be relied upon to produce safe, reliable and consistent returns. However, some investments come with significantly more risk than others. For example, cryptocurrencies, such as bitcoin, are viewed by many commentators as a speculative investment, only suitable for those willing to take a considerable amount of risk and willing to withstand heavy losses.
At Nutmeg, we believe that a diversified investment portfolio — with an appropriate proportion of cash, equities, bonds and commodities for your goals and risk tolerance — is a better way to maintain and build wealth over the long term.
Some examples of Nutmeg portfolios with varying degrees of risk:
As you can see, the riskier portfolios can have better returns, but also bigger falls.
2. Only risk what you can lose: how much risk can you afford?
Nobody really likes risk, but some are more able to tolerate it.
Knowing how you feel about risk is the first step in determining what sort of portfolio of investments is right for you. This is important as you need to know that you can stay the course if your investment falls in value, as it almost certainly will from time to time. Also, if your portfolio is too cautious, you may be disappointed by the returns you get.
At Nutmeg, we help people find their risk tolerance with a well-established and rigorously tested risk assessment. By answering ten questions, you can establish your attitude to risk which will help you understand how you feel about investment risk and determine what the right investment strategy is for you.
A good question to ask yourself is: ‘What would it mean for you if your investment fell in value?’. The above table gives some idea of what has happened in the past. Give some thought to how it would affect your plans and your standard of living.
If you have flexibility about when you need your money, you can leave the money to recover from a downturn. How long that takes has varied widely from a few months to a few years and will also depend on how it is invested. This is a very good way of managing risk, but requires the financial and psychological ability to delay cashing out your investment.
At Nutmeg, we show you what the downside may look like so that you can really think about what that would mean for you.
3. Nothing is risk free
Even leaving money in the bank involves some risk, that of inflation.
Sometimes people have a general idea of what they want from their investments, for example to keep up with inflation or to preserve their capital, but in trying to do any one of these you are likely to have to accept some level of risk. The beauty of investing carefully, across a range of assets is that your risk can be diversified and typically if one asset goes down, another will go up as the market moves to compensate. That’s why bonds can become more valuable as equities fall – there is more demand for assets seen as less risky – so it really is a good idea to hold both.
When you understand risk and know how much risk you want to invest in, it’s easier to see good investment as a great way to offset the general risks that are inherent in holding money and assets.
Being risk aware is crucial to good investing
People may also have a more specific goal, such as to build a pot of £10,000 in 10 years’ time to fund a dream holiday. Gauging risk will help you know whether that is realistic given the risk strategy, contributions and timeframe. We help you understand this with our projections which you can access any time by editing the risk level on one of your Nutmeg pots.
If you are going to fall short, rather than change the amount of risk, we will suggest changing your contributions or extending the timeframe. You can also reduce the amount you are aiming for. Alternatively, if you are going to overshoot your objective you can reduce your contributions, dial down the risk or bring forward the timeframe.
You can start today:
Once you’re ready, you can start investing with Nutmeg today. It’s simple, straightforward and we’ll be on hand to help you answer questions you might have.
Nutmeg is offering a special offer of no portfolio management fees for 9 months for Money Dashboard users. To take advantage of this offer, start by entering your email address on our partner page. You’ll then be able to see the sorts of returns associated with each type of Nutmeg investment, with a sample portfolio.
Starting your investment journey with Nutmeg is simple and straightforward, and we’ll be on hand to help you answer questions you might have.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance and forecasts are not reliable indicators of future performance. Learn what we mean by risk