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All regulated investment managers are at obliged by law to issue a caveat to investors pertaining to risk and by doing so ensure that the client is aware that the value of investments can go up as well as down. In the financial world, risk describes the range of possible returns on an asset and when considering your investments, it is essential to consider your personal attitude to risk. Most people are relatively cautious in this regard, favouring certainty over potential high returns. For example, most people would rather be sure of making 10% on an investment than having the potential to make 20% but with the risk of making nothing or worse losing money.
With all investing there is always the change of downside risk – the possibility that you could lose some of your money, and potentially all of it. For most people where assets are concerned, a bird in the hand really is worth two in the bush.
Holding cash in the bank is generally the least risky way to keep your money. Most countries have financial compensation schemes to cover account holders that ensure deposits are safe up to clearly defined limits. With bank deposits, you are sure of your return as banks are obliged to publish their modest interest rates, however you sacrifice returns for the sake of certainty. According to the 2013 Barclays Gilt Equity Study, the average return above inflation per year since 1899 was just 0.9% for cash.
By contrast, the return for shares averaged at 5% seeming to prove the widely held belief that investments involving higher risk reap better returns. The unlimited potential returns of investing in shares is what tempts many to put their cash into equities however there is the ever-present risk that a company will fail to perform, or worse, go bust, leaving the shareholder with nothing.
There are however, a number of ways for investors to minimise the risks posed by shares. The first of these is by purchasing funds. Funds spread your investment by buying shares in lots of different companies. Some will perform well, others less so but the two will cancel each other out, mitigating your risk and providing you with a consistent return. Historically, the UK equity market has been strong, giving better returns than cash, but even on the occasions when it falls, spreading your risk by using a fund is preferable to having all your eggs in the one basket that goes belly up.
Investing over the long term is another way to reduce your exposure to risk. The market rarely suffers for sustained periods – it may have a bad year, sometimes lean periods can last five or very occasionally 10 years but if you can afford to invest over the longer term, you are still statistically more likely to get a better return than cash. Over the course of a 20 year period a company’s value will fluctuate often dictated by economic conditions, but by keeping your investments during the downs, you give them the time to rise back up. Over the last 10 years, even taking into account the financial crisis of 2008, as a whole the stock market has still beaten cash for return on investment.
Time, however, may not be on your side if you need a return in less than 10 or 20 years. This is where a multi-asset approach can pay dividends. By allocating your investments to different asset classes which carry different levels of risk such as equities, bonds, property and hedge funds you further reduce the without having to sacrifice potential returns. Quality investment managers like Infinity’s partner Bestinvest specialise in building portfolios that balance and adjust the ratio of an investment portfolio held different asset classes to minimise the downside and maximise the potential return.
Of course, risk is very hard to measure. The best tool investment managers have to do this is the volatility rate. Volatility measures the variability of returns over a specified period and distils it into a number. This offers a means of comparing the risk factor of different shares, asset classes or funds. It can be useful but caution is advised as past performance is not necessarily a reliable indicator of future returns. This was illustrated when share prices dived after the financial crisis of 2007 following several years of low volatility.
Here at Infinity, we take great care to understand the risk requirements of our clients. For each client we carry out an in-depth assessment of their attitude to risk before suggesting investment strategies suited to their needs.
If you would like to find a free assessment of your attitude to risk get in touch for a free consultation or click below to find out the robust investment process that underpins how Infinity and Bestinvest look after our clients’ investments.
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