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Risk and return

Risk is the possibility of losing some or all of your original investment or in the case of cash, your spending power. Often, higher-risk investments offer the potential for greater returns but there is also a significantly increased potential for loss. Different types of investments have different risk profiles. And as you continue on your investment journey, you’ll come across the terms ‘risk’ and ‘risk profile’ a lot.

Risk means different things to different people. How you feel about it will depend on your individual circumstances and even your personality. Your investment goals and timescales will also influence how much risk you’re willing to take.

A good way to check how comfortable you are with risk is to think about your reaction to the following statements:

1) There's an 80% chance this investment will make money or at least repay your capital.

2) There’s a 20% chance this investment will lose money.

These 2 statements describe exactly the same investment risk. Their purpose is to get you to think about how you view your money. They also show that your attitude to risk can depend on the amount of money you can afford to invest.

As an example, let’s say you have quite a large sum of money to invest. You might be prepared to take more of a risk than someone with only a small amount. Then again, if you’ve got less money, you might be looking for greater returns – so could be prepared to take more of a risk. As we said before, it all comes down to your individual circumstances and investment goals.

All investments carry risk

As a general rule, the more risk you're prepared to take, the greater returns or losses you can potentially make. Remember though that nothing is guaranteed and you could lose some or even all of your money. Also, the risks from any particular type of investment aren't always the same. For example, you could lose more money from investing in developing-market companies than those operating in the UK and US markets. So consider where you are placing your investments.

Risk does vary between the different types of investments. For example, funds that hold bonds tend to be less risky than those that hold shares. But there are always exceptions – an emerging market or high-yield bond fund can carry greater risk than a fund that invests in shares of large companies from the UK, US and Europe. So never invest before doing your homework.

Can risk be managed?

Although nothing is guaranteed, you can aim to manage risk by investing for the long term and by investing in a range of different investment types and markets. As we said before, it’s also sensible to pay money into your investment regularly, rather than all in one go. This can help smooth out the highs and lows of the market and cut the risk of making big losses.

Funds vs shares

  Funds Shares
Are they diversified? Yes. Your investment is split across a wide range of individual investments, spreading potential risk. No. The performance of your investment is tied to a single company, so there's more risk involved.
How do price movements affect their value? If the value of one individual investment falls, this may be offset by rises in the value of other investments held in the fund. The value of your investment is directly linked to the price of a single company share. So if it falls or rises, so will your investment.
How risky are they? The structure of funds makes them generally lower risk than shares. Shares are high-risk investments because their value depends on the performance of a single company.
Who are they for? Funds are popular with a wide range of investors. New investors might use them to invest in mainstream markets, while experienced investors often also use funds to access niche markets. Shares are for experienced investors who have high value investment portfolios. You need to be comfortable analysing the performance and prospects of a single company and prepared to lose your money, eg, if the company becomes insolvent.

 

 

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