It’s widely understood that virtually all investment involves an element of risk. How much risk is usually linked to the potential reward. You may like to assess your own attitude to risk using our Risk Assessment Questionnaire.
Also, understanding the different types of investment risk will help you to determine your comfort zone and make better decisions.
Risk of inflation
“Inflation” is a word everyone will have heard of and some will be more familiar than others of it’s affect on investment planning.
Inflation, controls the general price of goods and services so economies try their best to avoid significant rises or falls so as to keep conditions stable. The aim for UK inflation, set by the Bank of England, is 2% per year, although typically inflation fluctuates below and, usually above this mark.
To use an example, income of £10,000 today would, in 10 years time, be worth just £8,200, with inflation at 2% per year. In 20 years, just £6,730.
Similarly, investments that are worth £10,000 today should ideally be at least £13,800 in 10 years time just to have kept their original value.
One role of the financial adviser will be to work with you to protect your investment against the effects of inflation and ensuring your portfolio grows by at least the rate of inflation every year to demonstrate growth.
Risk to capital
Capital growth may be the priority for you when deciding on investment options. For example, property and other equity investments can see significant growth over time, however, there is always a risk to a decrease in the capital value as well. If the value of a capital investment falls, sometimes it may recover but sometimes it may not or it may take many years to do so – this is the risk.
Diversifying investments helps to spread the risk. It’s often a case of not putting all your eggs in one basket.
Risk to income
As an alternative, income may be the driving factor when it comes to your preference for investment. Rather than equity investments which rely on growth, it may be more valuable to you to receive a regular amount of money in exchange for the funds originally invested. Rental income is an example of this. Many landlords are in fact not so concerned with the capital growth, instead they are just interested in securing a tenant who will cover the mortgage payments each month. Similarly, with equity based funds, dividends may be the key incentive for many investors.
The risk here lies in the income stream running out, so investors will always need to protect themselves against this risk by forward planning.
Risk of shortfall
The risk of shortfall is a common concern for investors. This simply refers to an investment not providing sufficient results when the time comes to draw on the investment or portfolio. Pensions is a good example.
This can be for a number of reasons, one being that the upfront expectation of performance is too high. Another reason is that the initial sum and contributions were not sufficient for the return required.
Using a financial adviser to give guidance on investment planning can help reduce exposure to these risks.
Complete our Risk Assessment Questionnaire to find out what your attitude to risk is.