Risky Business: How do I know whether I'm taking the right amount of risk with my investments?

Investment risk is not as scary as it sounds. When we as financial advisers refer to risk, we’re referring to the trade-off you make as an investor between the amount of fluctuation in the value of your investment you are willing to experience over time versus the potential level of return. The greater the expected level of volatility in the value of an investment, the greater the level of risk it normally is deemed to have. Generally, to compensate investors, a higher return is expected over the long term on higher risk investments.

Low risk investments are also known as defensive investments and include cash and term-deposits. They tend to have lower long-term returns but also less risk of loss capital or reduction in the value of your investment.

High risk investments are often referred to as growth assets and tend to provide higher long-term returns but also greater price fluctuations and potential loss of capital. These include investments in shares and property.

The degree of risk you have in your investment portfolio generally refers to the proportion of growth assets versus defensive assets. Some factors to consider when determining what level of risk or growth allocation is appropriate for you include; your age and available investment timeframe, your level of comfort with volatility, and your personal goals.

It is important to remember that all investments involve taking some degree of risk. Investment risk may be in form of the risk of loss of capital or risk of inadequate returns to achieve your goals. Bank deposits for example may appear to be risk free, however, they do carry the risk of not growing in line with inflation, meaning the real value of your funds decreases. As a result, being too risk adverse may mean you cannot reach your goals and need to consider making other trade-offs. Common trade-offs include working longer or compromising on the lifestyle you have in retirement.

Being overly conservative with your retirement savings in your younger years can therefore be very risky and you won’t be maximising the benefits of compounding returns. Compounding is where you receive returns on your previous investment earnings as well as the original investment and is particularly effective with long term investments.

A common strategy to reduce risk is to diversify your investments. We have all heard of the saying “don’t put all your eggs in one basket’’ meaning investing in only one or a few investments will have a higher degree of risk than investing across a broad range of investments and asset classes. The theory is that different asset classes generally perform well at different times and spreading your funds across different asset classes and different investments within asset classes, reduces the overall volatility. This also eliminates the risk of losing your total capital due to a single poor investment and tends to smooth investment returns over the long term.

It is important to remember that even with a well-diversified portfolio, risk cannot be eliminated completely and is very normal! As such it is important to find your

own level of comfort between risk and return so you can be well prepared to ride out periods of negative returns when they inevitably occur.

It is also not unusual for your risk profile to change throughout life. As investors age and get closer to retirement, they often believe they should move out of growth assets and invest solely in defensive investments. While protecting your investments is often more important at this stage of life, there can be a good argument for retaining part of your portfolio in growth investments, even if it is a lower portion than when working. It is important to remember that you could have another 30 plus years of living ahead of you and if your funds aren’t still growing, you run the risk of outliving your savings.

However, for retirees or those approaching this, there is no doubt a fall in your portfolio value can have a bigger impact if you are, or are about to start, drawing down an income from your funds. If you’re approaching this life stage you may wish to speak to your financial adviser about the strategies that may be appropriate for you to offer protection from falls in investments at this stage of your life, while still allowing you to remain on track for your retirement lifestyle goals.

Please speak to your financial adviser for more information on what level of risk is right for you.