Understanding how you feel about risk will result in an investment portfolio you’re comfortable with.
Your attitude to risk is a very personal and emotional thing. But when it comes to investing, it pays to be objective too and think about how much risk you are prepared to take within the context of your financial goals and your investment time frame.
As a general rule, the longer you have to invest, the more risk you can afford to take. So, just as a 20-something shouldn't be using a cash ISA to save for retirement, nor should somebody approaching their retirement be piling all their money into small technology stocks.
If you're more used to savings accounts that pay a pre-agreed rate of interest, paying money into an investment that could potentially see you lose money can be daunting.
But this needs to balanced out against the risks of leaving your money in a savings account where it's highly likely it will lose value in real terms as its buying power is reduced by inflation.
For many cautious investors, not taking enough risk becomes a very risky strategy to employ. You may not lose money but you may not make enough to achieve your financial goals.
By the same token some adrenalin junkie investors may need to tame their strategy in the final years of their investment when their priorities should shift from capital growth to capital appreciation.
Find out how much risk you should take with our quiz
- Add 2 points every time you answer a)
- Add 5 points every time you answer b)
- Add 10 points every time you answer c)
1. If someone offered you £1,000, or the chance to gamble it on decent odds for a potential £100,000, which would you choose?
- a) I'd take the £1,000
- b) Could I bet half of it?
- c) I want to win the £100,000
2. If a fund fell 50%, what would you do?
- a) Sell up and go for something less risky
- b) Investigate the fund, and if it was still sound, hang on for a recovery
- c) Buy more to take advantage of the low cost
3. How do you feel about the current market?
- a) Terrified
- b) Confused
- c) Optimistic
4. If the market falls this year, what will you do?
- a) Move everything into cash
- b) Keep track of how my funds are going compared with others in their sectors, to be sure my managers are keeping on top of things
- c) Look out for sectors that have fallen particularly far and now present a buying opportunity
5. How long do you plan to invest for?
- a) Less than five years
- b) 5-10 years
- c) More than 10 years
6. What do your other savings and investments look like?
- a) I have some cash in the bank
- b) I have some cash, plus investments in one or two funds
- c) I have a large and diverse portfolio
7. What state are your finances in generally?
- a) I spend everything I have – and sometimes more
- b) I have balanced my monthly budget and have a few thousand extra in an account
- c) I live within my means and have six months’ expenses set aside in case of emergencies
8. How do you view this year’s ISA allowance?
- a) It’s a very big part of my portfolio
- b) It’s one of a few ISAs I have built up, and I expect to have more in future years
- c) It’s a drop in the ocean
9. What kind of return do you need to get?
- a) I'm happy with a stable return between 1% and 2%
- b) I am looking for single-digit returns. I would be happy to accept up to 10% loss in any normal year, but I understand there are years when I could gain or lose considerably more
- c) I want between 10% and 20% a year, but I know there will be years when my portfolio rises or falls over 50%
What's your attitude to risk?
0-20 - You are a very low-risk investor but should you stick with cash?
You fall into this category because you chose the most conservative answers for more than half of the questions.
There are a number of very sound reasons for choosing cash, however. You may, for example, only have a short period over which to invest. If you can’t commit to five years or more, cash might be one of your best options, given other assets may be too volatile.
Alternatively, you may need to establish an emergency fund. Before embarking on more advanced investments, you need to have a few months’ worth of expenses saved up in case of any unexpected outgoings. Cash is the only suitable asset for this, as you never know when you might need access to your money.
Again, some people may just not be able to face the thought of losing money, even in the short term. You don’t want to lose sleep at night.
However, there is a price to pay for conservatism. If you opt for cash, you need to be prepared for the fact that returns are going to be disappointing given the current ultra-low interest rate environment.
Think about your investment targets: do you need to set aside more money or, if your time-horizon allows, do you need to consider taking a little more risk?
You also need to think about the longer term. Equities can experience big falls, but they tend to outperform cash savings over the long term. In the vast majority of 10-year periods over the last 50 years, equities have beaten cash hands down. So you should at least be aware of the potential you could be missing out on if you decide to stick with cash and ignore equities.
Then there’s inflation. It’s not an immediate concern, but when it returns, cash will struggle to make significant gains. Remember, cash is not a risk-free asset in these circumstances.
If you do opt for cash, it’s worth finding the best available rate and make sure you always switch to a better deal as soon as your initial rate drops. Make sure you don’t pay any tax on your interest too by choosing a cash ISA.
25-45 - You are a low-to-medium risk investor and should consider a mix of cash, shares, bonds and other assets in your ISA.
You may have fallen into this category because you gave the middle-of-the-road answer every time, in which case you need a balanced portfolio and you’re in the right place. However, it may also be because you have conflicting attitudes towards risk – for example, you may have a long time horizon and be looking for a good return but have concerns about risk generally.
If this is the case, before you start assembling a portfolio, you should ask yourself some questions to determine where you need to compromise. Think about whether you really need such a large return. Can you afford to put more investment in and accept a smaller return?
If so, you can compromise on return and opt for a cash ISA. If not, you may have to compromise on the risk you are willing to take and use equities, bonds or other assets.
Low-to-medium risk investors need to think about mixing asset classes like this to suit the level of risk they can handle. A useful way to build a mix of assets is with funds that already embody them. Mixed asset fund funds offer a balance of equities alongside other assets, including cash and bonds. Funds in the mixed investment 0-35% shares sector cap their stock market exposure at 35%.
If you want a more bespoke mix, you can open an ISA with interactive investor. This will allow you to spread your investments across a selection of funds. So, you could pick a bond fund, an equity fund and alternative assets such as commercial property. You can separately invest part of your asset allocation in cash, and mix and match the proportions depending on what suits you.
50-75 - You are a confident investor and should consider a Stocks & Shares ISA.
You have fallen into this category because you gave middle-of-the-road answers to most of the questions, but some of your answers also indicated a willingness, ability or need to take on more risk. Before you invest, you should look at any question you answered A or B to and consider where your priorities lie – if, for example, you only have a short period over which to invest, equities are unlikely to be the right choice.
However, once you’re happy that equities are the best approach for you, you need to start out by building a core equity portfolio. This should consist of a mixture of UK and global funds.
Any portfolio will need balance; it shouldn’t be entirely made up of equities. You need to reduce the risk by diversifying over a number of asset classes, including fixed interest and commercial property.
80-90 - You are a high-risk, experienced investor, who can look for more volatile opportunities within Stocks & Shares ISAs.
You have ended up in this category because you already have a diversified portfolio, are investing for the long term and have an appetite for risk. This means you’re likely to be prepared to take some gambles with your ISA allowance because you have sufficient investments and a safety net elsewhere in your portfolio to fall back on. So your ISA may include more speculative funds, investing in areas with tremendous prospects for growth but with the risk of great volatility – for example funds investing in smaller companies or those investing in emerging markets.
Beyond the realm of funds, you could also consider buying a self-select Stocks & Shares ISA and using it to buy specific stocks. This concentrates the risk even further, but is a useful option for those who regard their ISA allowance as a relatively small part of their portfolio.
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.
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