What’s your attitude to risk?

What you’ll learn:

• What investment risk means
• How time and diversifying investments can help reduce risk
• Why you need to establish how much money you can afford to lose.

The word risk is often associated with danger. But not everyone’s view of danger or risk is the same. Someone might consider adding extra chilli to their food as risky enough, while others feel that scuba diving among sharks is an acceptable level of peril.

What they both want is the potential reward they get in return for the level of risk taken – whether it’s the modest return of spicier tasting food or the massive adrenaline thrill from an adventurous activity.

The same applies to the risks you're prepared to take with your money.

The more risk you take the greater the potential rewards. The price for this is living with a level of uncertainty. That means the risk of losing some or even all your money. If you want certainty, you’ll probably stick with cash for your savings.

Your attitude to risk is partly down to what you’re like as a person, whether you’re a natural risk-taker or if you tend to be more cautious.

But understanding what risk means when investing – and how to manage it – can help you decide the level you’re prepared to tolerate.

Investing generally means putting money into the shares of companies. If you put all your money into just one company’s shares that’s highly risky. Although that company could prosper and your investment balloon in value, it could equally go bust – taking all your money with it.

Consider reducing risk

Step 1

Spread your investments.

Buying the shares of several companies can help reduce risk – if one wobbles or fails then hopefully the others won’t be having such a bad time.

A popular way to reduce risk further is to invest in funds. These are where investors pool their money with others to invest in a broad mix of companies, reducing the impact on your pot if one or two go wrong. You can reduce risk further by choosing funds that invest across different assets, sectors and countries.

Step 2

Have time on your side.

Before investing, ask yourself what you want the money for – and when. Even the most robust companies see their shares go up and down in value and there's always a risk you could lose money.

But the more time you have on your side – say 10 years but at least five years – the more bumps you'll be able to tolerate on the road to, hopefully, building your wealth.

If you need to get your hands on the money over a shorter period, perhaps for something looming soon like university costs or a wedding – or if you plan to retire in the next year or two – you’d probably consider taking a cautious approach – even if you feel you have a high tolerance for risk. This is because if things go wrong, you have less time to recover any losses. In these circumstances cash savings or perhaps bonds are a safer place for your money.

While it’s not always the case that your investments will do better over the long term, by taking more time it will mean your money has more opportunity to bounce back from any downturns. In addition, the longer you stay invested the more you have to benefit from the potential impact of compounding – where you earn returns on returns, but you do have to accept that no matter how long you invest for, you can still lose; that’s the risk.

Step 3

Decide what you're prepared to lose.

Thinking about what you could afford to lose might be uncomfortable but it’s a vital part of working out your ability to withstand risk. It’s worth considering what the impact on your financial situation would be if your investments fell by different amounts and whether you could cope with the uncertainty.

Things to think about

There's never zero risk in investing. And there’s no right or wrong attitude to risk. Risk is personal to you and is based on your circumstances, your goals and ultimately whether the thought of investing makes you feel nervous or completely calm or somewhere in between.

Once you’ve worked out your approach, you can start building a pot that reflects how you feel about investment risk. Your feelings may change over time – but you can adapt your position as necessary.

Remember that all investments carry risk and there’s always the possibility that you could lose money or get back less than you invest. If you’re not sure what your attitude to risk is and you feel you need help, you may want to think about getting independent financial advice. You’ll have to pay for any advice you get, but it may help you decide what level of risk is right for you.