A new year is a great time to consider how much risk you are taking with your money
Far too many opt for so little risk that savings cannot grow effectively and the value is eroded by inflation.
‘Risk’ is a pejorative word. It implies hazards and, at its furthest level, a high chance of incurring losses. No adviser would suggest placing all one’s profit “and risk it on one turn of pitch-and-toss”, as Rudyard Kipling wrote In the Neolithic Age.
Investment risk is the measurement of the potential gains and losses that can be achieved.
To establish your risk capacity, consider your personal circumstances and how much loss you could handle. “You may or may not be a natural risk taker, so it’s important to feel comfortable with your investments,” recommends adviser Willis Owen.
Good investing is about balance. Diversity is the key to spreading risk, not only in terms of the product but also the provider.
It is important to have the knowledge and experience to understand the risks involved and, in the absence of financial education in most schools, never be afraid to ask an adviser or potential provider.
When the term ‘risk’ is heard in relation to saving, the first thought tends to be the loss of capital. However, risk goes much further and covers the full extent to which investments make or lose money.
Individuals can have different risk profiles for a variety of financial objectives. A cautious approach might, for instance, be taken to pension savings and a higher risk for investments made for the long-term benefit of children or grandchildren.
For an objective approach, it is often best to seek the help of an independent expert who will not be swayed by sentiment or short-term noise. Some people still keep a consistently underperforming holding simply because it was inherited.
“A common mistake is having investment decisions dictated by short-term sentiment. This is demonstrated by investors’ willingness to take more risk after investments have already performed really well,” warns Kelly Kirby, chartered financial planner at Chase de Vere, part of Swiss Life.
Kelly says more people invest when markets are riding high. Two recent examples are the technology boom at the start of the Millennium and the sudden and perhaps irrational interest in cryptocurrency like the bitcoin.
By contrast, when stock markets are in the doldrums and investment losses have already been made – perhaps theoretically but not realised – many investors are reluctant to take risks for fear of losing more money.
The result is that too many people take excessive risk and buy at the top of the market and take too little risk and sell at the bottom.
Asset allocation is the best way to manage investment. This means holding the right blend to meet circumstances, objectives and risk profile. For most savers, a sensible blend is a mix of equities (ordinary shares), fixed interest, property and cash.
Placing more money in cash and fixed interest will ensure a greater level of capital protection but have very limited growth potential.
Once the mix has been settled upon, it is wise to rebalance regularly. A collective, such as an open-ended fund, may have been bought with a low risk rating but has decided to change course and has been re-rated to a higher risk level since your purchase.
Advisers recommend undertaking such a review every six or 12 months. However, watch that the subsequent transaction costs involved do not outweigh any benefits. Some platforms will make no charge to switch between funds, such as Hargreaves Lansdown.
Look at risk profiles before investing. Fund Calibre’s research team assesses the overall risk of a collective by analysing such factors as:
volatility within its sector
level of risk involved in the region or sector
size and number of companies within the fund
risk controls imposed by the manager
use of derivatives and currency.
It then assigns an overall risk rating of one (lowest) to 10 (highest).
Financial goals are important and will impinge on the level of acceptable risk. Clearly there needs to be sufficient return to repay a mortgage and to build up a pot for retirement.
There should also be a readily accessible source of money for any emergency. Whilst everyone in work should have both critical illness and income protection cover, there will be a time gap before insurers will pay out when bills needs to be paid.
Mutual societies generally have low to medium risk funds and have the appeal that members are the shareholders. Sheffield Mutual’s with-profits fund has a high percentage in property which is useful to those who otherwise only have this sector in their home.
“If you don’t have a long-term view of at least five years, you should not be investing at all,” says Myron Jobson at Interactive Investor.
He suggests looking at fund names for a clue as to their profile, such as balanced, cautious and adventurous. He stresses to “look under the bonnet” and, “whether high or low risk, we should all be looking at geographical diversification”.
Adam Martell, investment manager at Charles Stanley in Leeds, says one of the most important concerns is “concentration risk”, meaning having too much capital exposed to one stock, geography or asset class.
Liquidity is an underestimated risk. It accounts for much of the downfall of Woodford’s Equity Income fund which invested in small, unlisted stocks which under pressure were not easy to sell.
The once lauded manager raised a massive £4.9bn but investors were left holding a fraction of their savings.
Bestinvest, part of Tilney, provides a valuable function for investors with its regular Spot the Dog report where it names and shames underperforming funds. To counter, it also reveals ‘pedigree picks’.
Two of the most reliable sectors for consistent performance are insurance (where companies need to maintain large reserves to meet liabilities which are held largely in bonds and cash) and defence (where there are long-term Government contracts). Utilities are subject to threats of nationalisation.
Opt for investment trusts rather than open-ended like unit trusts. The former are closed ended which means that a fixed number of shares are issued and, in any difficulty, can be traded.
Those in unit trusts like M&G Property Portfolio, which was suspended last month, trap savers trying to exit.
If you have only a small sum to save, consider a monthly equity plan which reduces volatility but in a fund still means a professional manager will select the best companies available. A cheaper option is a tracker – like the Vanguard range, such as its Life Strategy range – which will try to mirror a published index of shares.
For all but the highest risk takers, avoid peer-to-peer lending where money is lent to people or firms for interest. Many such enterprises have collapsed and there is no protection from the Financial Services Compensation Scheme.
This scheme protects the first £30,000 with an investment firm, and £85,000 with a deposit-taking firm.
Conal Gregory is AIC Regional Journalist of the Year.