Investment risk is something all current and future investors must come to terms with. No investment is ever risk-free, but conversely, not all investments are as risky. Whether you’re looking to make your first investment or want to reassess your portfolio, here’s everything you need to know about managing investment risk.
What is investment risk?
When most people invest, it’s so they can earn more money further down the line. But investing is inherently risky, meaning there can never be any guarantee that you’ll make money on your investment. You could potentially lose everything, including the entirety of your initial sum.
All investments have a level of risk, but some are less risky than others, which is why doing your research before making an investment is so important.
Do all investments carry the same risk?
Investments sit on a sliding scale of risk. Investing in something like a government bond is considerably less risky than investing in a start-up company without any track record, for example. What makes things a little more complicated is that assets with lower levels of risk will often return less profit. If you invest in a more risky product, while you’ll have taken a gamble, you could earn a lot more from it. There’s no definitive answer, and each investment is different, but some carry more risk than others.
Gold – Gold is famously one of the least risky investments you can make, but its returns are comparatively much lower than higher-risk options.
Bonds – Bonds are investments you can make in everything from the US treasury to big corporations. Bonds serve as loans, raising cash for the recipient on the promise that you’ll receive a bigger pay-off over the long term. Government bonds generally carry less risk than private company bonds – which are often called ‘high yield investments’.
Shares – Shares are typically seen as more risky investments to make, as the value of your investment can go up or down based on stock markets. While there are some safer shares you can buy, they’re inherently a riskier asset class than bonds due to the fluctuating nature of stock markets.
Trusts – Trusts are investment funds that pool your money with several other investors. The trust then invests this money into a portfolio of stocks. Spreading the investment across multiple stocks helps to mitigate some risk, but trusts are still subject to the rising and falling values of stock markets, so aren’t a guarantee that you won’t lose your initial investment.
Cryptocurrency – Cryptocurrencies are newer investments and one of the riskiest, particularly if you’re not a seasoned investor. The value of cryptocurrencies such as Bitcoin has fluctuated dramatically with little warning over the last couple of years, so only more experienced investors might want to invest in digital currencies.
Some investment classes are easier to risk assess. Take government bonds as an example; you can get an unbiased picture of a country’s financial health by checking credit rating agencies, such as Moody’s and S&P. These work in the same way that credit scores can affect your credit history and financial future.
What types of investment risks are there?
Many different risk factors could affect the value of an investment, and some assets may be exposed to multiple factors simultaneously.
Here are a few investment risk types that you might need to be aware of:
Business risk refers to the simple reality that a business’ profits could decrease, meaning that it, in turn, will not be able to pay you back.
Interest risk occurs when a change in interest rates lowers or increases the value of your investment.
Political risk affects investments that could face bumps in the road depending on future legislation, safety fears, or a changing political outlook.
Market risk is often seen as one of the worst kinds of risk and arguably the most unpredictable. Any investment can be affected if a significant financial event, such as a recession, causes markets to collapse, wiping away much (or all) of its value without any warning.
The above are the most common risk factors, but there’s more out there. That’s why seeking impartial financial advice and fully understanding what you’re investing in matters so much.
How can I manage risk?
Ask five different investors, and you get five different answers as to how you should go about managing your investment risk. There is no sure-fire, guaranteed way of avoiding risk when you invest. However, one of the most common pieces of advice when making investments is not to risk everything on a single asset. Instead, it is better to invest small amounts in a range of different assets – this way of managing investment risk is known as ‘diversifying your portfolio’.
By keeping your investments smaller and spreading them out, you don’t have so much riding on each one. Even if one investment loses value, some of your other investments may recoup the loss. Whether you’re a seasoned investor like Warren Buffet or a total newcomer, mistakes can, and unfortunately do, happen. But, thanks to diversification, one mistake doesn’t need to cost you all your investment money.
If you’re a new investor looking to make a few investments without taking on bigger risk, a smart portfolio of assets could include a government bond, a corporate bond, a cash investment, and a property. These are all considered to be comparatively lower-risk investments.
A more seasoned investor looking to take on more risk in the hopes of bigger profits could choose to invest in penny stocks, equities, high-yield investments or a high-leverage exchange trade fund (ETF). These can be riskier investments.
How much risk is too much?
There is no right answer to this question, as the result will vary depending on your personal appetite for risk. However, the most crucial question to ask yourself is how would it affect your financial position if you lost everything you’d invested?
If you have higher disposable income, are a more experienced investor, or are prepared to stay invested in certain investments over a longer term, you may be comfortable with higher levels of risk.
On the other hand, if you have a smaller budget, are new to investing, or find the idea of your investments losing value uncomfortable, you may be better off sticking to less risky investments.
How can I invest safely?
Several institutions are dedicated to ensuring that scams, schemes and poor trading practices are stopped before they reach you. As mentioned above, rating agencies operate in most countries' financial markets. Their primary role is to analyse companies, stocks, shares, and bonds and rank them based on how risky they may or may not be.
Beyond these agencies, there are also financial regulators monitoring markets. In the UK, there is the Financial Conduct Authority (FCO), Financial Services Register (FSR), Companies House, Financial Ombudsmen, and the Financial Services Compensation Scheme.
But if you make a poor investment decision, there may be nothing you can do to recoup your losses. That’s why it’s crucial to make sure every choice is an informed one, backed up with as much information and expert advice as you can get your hands on.
Investing always comes with risk, but not all risk is bad. If you’re looking to invest wisely with the support of a financial expert on your side, Unbiased can match you with the perfect adviser for your needs right now.