It doesn’t matter what your goal for investing is, you will inevitably have to deal with the risk associated with the practice. One of the first steps to take when you decide to invest is to ascertain your attitude towards risk so you can make informed decisions and improve your chances of achieving your goals.
This does not constitute advice and advice should be sought in all instances before acting on it.
What is risk?
Risk is the possibility of losing some or all of your original investment. Usually, the higher-risk investments produce the greatest returns, but they come with a higher chance of losing money.
But risk means something to different to everyone – how you feel will depend on your individual circumstances and will change throughout your life. Your goals, how much you’re investing, and when you start investing will all play a part in how much you’re willing to risk.
There is no such thing as a “no risk” investment, but risk will vary depending on the investment. Investing directly through shares is an option, but investing indirectly through an investment fund – where your money is pooled with other investors and spread across a variety of investments – will help to reduce risk and might be the best option for you.
Inflation and interest rates
Even though there is always a chance you could lose money with investing, merely putting your money into savings – something most people view as the safe option – also runs that risk. Currently, inflation is high and that means your money is worth less now than when you first started saving. The buying power, or real value, of your money is lost over time and because interest rates won’t always keep up with inflation.
Even though stock market investments normally beat inflation and interest rates in the long run, you do still run the risk that prices will be low when you need to sell. Unfortunately, this means your return could be poor or if prices are lower than when you bought, you could lose all the money you invested completely.
There’s no way to avoid risk full stop, but you can manage it by investing in a variety of assets and regularly contributing to your investments rather than paying in a lump sum.
Types of risk
No matter what you invest in, you will always be exposed to some kind or level of risk. Here’s a rundown of other kinds of risk you could run into:
Credit risk – The risk of not achieving a financial reward due to a borrower’s failure to repay a loan or otherwise meet a contractual obligation. This is linked to the potential return of an investment, with the most notable being that the yields on bonds correlate strongly to their perceived credit risk.
Liquidity risk – The inability to access your money when you want to. If you hold your assets directly, liquidity can be a real risk.
Currency risk – If you invest internationally, you could lose money because of fluctuating exchange rates.
Interest rate risk – Changes to interest rates impact your returns on savings and investments. Even with a fixed rate, the interest rates in the market could fall below or rise above the fixed rate, which could affect your returns relative to rates available elsewhere. Interest rate risk is a particular risk for bondholders.
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