Understanding investment risk What is investment risk?
You can't plan financially without understanding investment risk. Many people, when they hear about 'risk', think automatically about the chance of being defrauded or not getting all their money back. This 'capital' risk is important, but it isn't the only type.
Other types of risk involve uncertainty and unpredictability. When you make an investment, it can be difficult to say with any certainty what you'll get back when you finally cash it in. Share prices fluctuate, interest rates vary and inflation is a risk too. Just concentrating on capital risk and ignoring these other risks can mean you take too cautious an approach.
Understanding risk means identifying your own attitude towards it and identifying the different types of risk. Then you can pick up tips for minimising the chances of things going wrong.
Investment risk of different types of assets.
There are a number of different asset classes that you can invest in, each of which come with their own risks. The four main asset classes are cash, bonds, property and stocks and shares (equities).
Cash is the least risky of the four but it tends to deliver low returns, which means the value of your money can be eroded in times of high inflation.
Action point: Learn more in our guide to cash as an asset class
One step up the risk ladder is government bonds, or gilts, followed by investment grade corporate bonds, where you effectively lend money to large companies in exchange for a fixed-rate of interest.
Action point: Corporate bonds and gilts explained - get to grips with the different types of fixed interest investments
Investing in commercial property, such as offices, supermarkets and warehouses, can grow your money through rental income and growth in the value of the property you own.
Action point: Commercial property investment - find out more about the different types of property investment
Stocks and shares, commonly known as equities, are seen as the most risky asset class, as stock markets can be highly unpredictable. Investing in UK equities is considered as lower risk than US equities, while emerging markets (such as India, China or Brazil) equities are viewed as the highest risk as the companies you are investing in are less well known.
Action point: Investing in equities - all you need to know about investing in stocks and shares
Investment risk - simple rules to follow
- The greater return you want, the more risk you'll usually have to accept
- The more risk you take with your investments, the greater the chance of losing some or all of your initial investment (your capital)
- If you're saving over the short-term it's wise not to take much capital risk. So what you are investing for and when you'll need access to your money will have a big impact on what types of investments are right for you
- If you are investing for the long-term you can afford to take more risk as your money has more time to recover from falls in the markets
- Investing in share-based assets has historically proved to be the best way for providing growth that outstrips inflation. There is a risk attached but, when you invest over the long-term, there is more time to recover your losses after a fall in the stock market.
The Investment Management Association has a helpful table describing the different types of investment risk and how you can mitigate them.