Interactive Investor

Are you striking the right balance on risk and reward?

31st March 2021 16:11

Myron Jobson from interactive investor

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Taking too little investment risk can be as concerning as taking too much.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

  • interactive investor has a section on its website, Risk and You, as well as a section for beginner investors
  • ii Quick Start recommendations for beginner investors provide a range of ready-made portfolios for a range of risk appetites

The Financial Conduct Authority (FCA) last week published a report issuing a stark warning to young investors about investment risk in the wake of the cryptocurrency boom and the GameStop saga.

While it is entirely right and appropriate to highlight the dangers posed by such investments (among others), it is important to put investment risk into context as taking too little risk can mean that you won’t achieve your goals.

Calculations by interactive investor found that someone earning £20,000 per year and making the minimum total workplace pension contributions of 8% (including employer contributions), from age 23 to 68, could add an extra £111,637 to their pot at retirement if they increased their risk target to 5% annual return, instead of 3% a year return (£262,389 versus £150,752).

Increase your monthly investment by £25 per month, as well as increasing your risk to a targeted 5% annual return, and you could add a further £50,000 to your pension pot over a working lifetime (see table below). And that’s not even taking into account salary increases.

If you up your risk profile to seek out a 7% annual return - higher risk, and potentially less sustainable - you could have £323,603 more in your pot at retirement (£474,355 versus £150,752), even without additional contributions.

These types of returns are clearly hypothetical and not guaranteed, but historically speaking, nor are they outlandish - although a 7% annual return seems ambitious in these uncertain times. But it is useful to think about risk and reward under a range of scenarios.

Myron Jobson, Personal Finance Campaigner, interactive investor, says: “As parents, we tend to want our children to follow their dreams, but without giving us too many grey hairs in the process. There is a tension here that can also extend to investing – take too much risk, and you could lose more than you can afford. Take too little, and those dreams can stay just that – dreams. There is risk in everything.

“Risk is an intrinsic part of investing, and the calculations illustrate how even a relatively modest shift of risk profile can make a big difference over the long term. In fairness, there are never any guarantees, and hypothetical scenarios are always far less nerve-racking than making real-life decisions – but they are a good way to test your thinking. 

“With no additional pension contributions beyond the 8% total employer/employee minimum but switching from a 3% to 5% targeted annual growth rate, you add almost £112,000 to your hypothetical retirement pot over a lifetime of saving. Increase your contributions by £25 per month on top of that, and your pension pot could be £50,000 higher. In short, it’s worth playing around with risk and thinking about how even modest extra amounts can add up.

“The concern outlined by the City watchdog last week is of an emerging cohort of young investors who have not grasped the concept of investment risk, instead relying on gut instinct and allowing their investment strategy to be influenced by social media.

“There are a number of simple things young and beginner investors can do to ensure a portfolio is sensibly structured. The key is to know your financial goal, investing time frame and your tolerance for risk – i.e., how bumpy a ride are you prepared to take as the financial markets inevitably ebb and flow? This is when you need to stay disciplined and focused on your long-term goal.

“The challenge for new investors is to resist the urge to invest in a particular proposition for fear of missing out. It is important to understand what you are investing in - funds and investment trusts, which use a professional fund manager to spread your risk globally, are a good place to start.

“interactive investor has a range of ‘Quick Start’ selections for beginner investors, that are low cost and cover passive, and active options, with the active range having a sustainable emphasis.

“In essence, we need more conversations and education [about] the impact of even increasing your contributions a little, and/or, reassessing your attitude to risk. That’s not to say we should all be ramping up our risk profiles – far from it. But we need to have more sensible conversations about risk and reward and how too little risk can also be potentially damaging to your portfolio.”

Table 1: £20,000 starting salary, start investing from age 23 straight through to 68

Annual return

3%

5%

7%

8% auto-enrolment

£150,752

 £262,389

 £474,355

8% auto-enrolment with an extra £25 per month employee contribution

£179,018

 £311,587

 £563,297

8% auto-enrolment with an extra £50 per month employee contribution

£207,283

 £360,785

 £652,238

*Table does not consider inflation or pay increases and is for illustrative purposes only. These are assumed annual returns and for illustrative purposes and are not guaranteed.

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