Get to grips with investment risk

In this episode, Clare interviews Dr. Peter Brooks, Barclays’ Head of Behavioural Finance, to find out how perception of risk influences our decision making when investing.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

Clare: Joining me once again on Smart Investor is Barclays' Head of Behavioural Finance, Peter Brooks this time to chat about investment risk and how we can work out what level of risk is best for us. Welcome again, Peter. So what is investment risk?

Peter: Investment risk actually encompasses a lot of different things. The main thing that people will think about is this element of volatility in the markets. That's a horribly technical term but not one you should be scared of. So as markets move up and down and over a bigger and bigger range that's going to seem like it's riskier as an investment. So if the ups are bigger and the downs are lower that's what people are going to say is a fairly high-risk investment. If those ups are fairly small and those downs are fairly small that's going to be a lower risk investment.

Clare: And how do investors think about risk?

Peter: Investors don't think about risk in quite the same way. So investors will typically think about the chance of something really bad happening which suggests they are actually more focused on the downside rather than on the upside. So as yet I haven't met an investor who's told me "You know what? That upside being bigger than I expected it to be "that felt really risky to me." That's not the way that people think about it. That creates a bit of a problem because people become very nervous in the down markets as well because risk tends to hit them the perception of risk tends to hit them a little more when the markets are falling.

Clare: One of the things we're always told is that it's really important to think about risk before we make an investment. So how do you go about working out what your risk profile is?

Peter: Working out your risk profile is actually one of the most difficult things you can do as an investor and it will often disappoint people when they think there is a science involved when actually it's definitely more art than science. Two things to really focus on when you are trying to decide. The first one is around your financial circumstances and what you're trying to achieve and how long you're investing for. The longer you can invest for the more ups and downs in the market you may see but actually time gives you a huge advantage. If your time horizon is 20, 30 years away, maybe for your retirement you have the chance to allow the markets to recover from any dips and that allows you typically to bear a greater degree of risk. But on the flip side as an individual you're going, "Actually, am I an adventurous sort of individual or am I a cautious sort of investor?" And if you're cautious that might pull back some of that risk a little bit and even though you have a very long time horizon you might need to take a little bit less risk in order to be comfortable with the risks that you're taking because even over the very long term, returns are not guaranteed. You could still be making a loss. So actually if you're cautious that might be the dominating thing for you in that decision.

Clare: So I guess that's the key, isn't it? It's what you're comfortable with because regardless of your time horizon you've still got to be able to sleep at night and you don't want your investments to be keeping you awake.

Peter: Absolutely. All the experience that we've seen as a bank and in terms of my work in behavioural finance it shows that people who cannot stay invested through all the market conditions really struggle to meet their goals and their objectives so getting it right is absolutely crucial.

Clare: Great. Thank you very much, Peter.

Peter: Thanks for that. You're welcome.

Clare: For more information on how you could become a better investor check out our website.

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