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Shortfall risk explained

By Michael Trudeau

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Shortfall risk explained

Learn how to avoid running out of money in retirement.

Shortfall risk means failing to reach your investment goal because the return you make on your investments is too low.

Lets say, for example, you want to save £20,000 over 10 years and can get a return of 3.45% after tax from a savings account. This means you'd have to save £140 a month to reach your target. If you can only save £100 a month, you'd only be able to make £14,300 over the same period, leaving you more than £5,000 short of your target.

To reduce shortfall risk, you need to invest at least some of your money for a higher return.

Shortfall risk and investment objectives

It's important to think about your investment objectives before choosing how to invest your money. You might be saving to fund your retirement or with a more specific goal in mind, such as saving a deposit to buy a house.

Once you decide what you're saving for, you can decide how much you would need to invest, how long you have to do it and how you could best achieve the returns you want. You need to be realistic about how much you want to get back from your investments and fully understand what you're investing in and why.

It's also important to remember that past performance isn't necessarily an indication of future performance, so the level of growth you might expect from a specific investment is never guaranteed.

Find out more: Which? investment portfolios – we've created a unique set of investment portfolios that can help you decide where to invest your money based on how much you're willing to put at risk.

Long-term investments and shortfall risk

The longer the time frame you have, the better chance you have of managing shortfall risk. If you're only investing for two or three years, then a bad year could leave you without enough time to recover what you've lost.

If you're investing over 10 years or more, however, your portfolio will have more chances to recover from any short-term setbacks. You also have a chance to switch to safer investments such as cash or bonds, rather than equities, as you approach the end of your time frame to protect any gains, or protect against further losses.

One important way to protect yourself against large losses to the value of your investments is to spread your risk by investing in various asset classes.

Find out more: Asset allocation explained – find out how to spread the risk of investing and why it's so important.

  • Last updated: March 2016
  • Updated by: Michael Trudeau