Why is investment risk important?
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 of 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.
What are the risks of different investments?
There are a number of different asset classes that you can invest in, each of which comes with its own risks. The four main asset classes are cash, bonds, property 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.
Find out more: Cash as an asset class – how to get the best returns.
One step up the risk ladder are 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. High-yield bonds, also known as 'junk bonds', are an even riskier option because they deal with companies seen to have a high risk of default.
Find out more: 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, but can be illiquid - meaning it can be hard to sell if you need to access your money.
Find out more: Commercial property investment – the different types of property investment.
Shares, also known as stocks or equities, are seen as the riskiest asset class, as stock markets can be highly unpredictable. But some markets are considered riskier than others.
Investing in developed markets such as the UK and the US is considered relatively safe compared to other equity markets, although these contain their share of higher risk options, too, while emerging markets (such as Brazil, China and India) equities are likely to be more volatile.
Buying shares in geographical regions less-frequented by investors can be expensive and the shares can be comparatively illiquid.
Find out more: 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're 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.
Find out more: Fund supermarkets reviewed – our unique ratings for leading investment brokers.