Investing 101: 5 essential questions you need to answer to balance risk
When you’re making investment decisions, balancing risk is an essential part of the process. Creating a risk profile can help you understand which investments are appropriate for you.
Last month, you read about the benefits of investing and how it could boost your wealth over the long term. While investing can be a valuable way to increase wealth, it also comes with risks. So, read on to find out more about investment risk and five of the key factors you need to consider when deciding how much risk to take.
All investments carry some risk. You cannot guarantee returns and you may not get back the full amount you invested.
However, the level of risk can vary greatly between different investment opportunities. So, understanding how much risk is appropriate for you is vital. Before you invest, answering these questions can help you balance potential returns and risk.
1. What is your investment goal?
One of the first things to consider before investing is to set out why you want to invest.
The level of investment risk that’s appropriate for creating a base income in retirement could be very different than if you’re investing to increase your disposable income.
How important goals are to you may also affect how much risk you want to take. For instance, if you’ve built up a nest egg to support your child through university, you may be reluctant to take a higher level of risk because you don’t want to potentially lose your savings, even if it could mean greater returns.
2. What is your investment time frame?
Setting an investment goal is also essential for understanding how long you’ll be invested for.
As a general rule, it can be sensible to invest for a minimum of five years. Historically, markets have delivered returns over a longer time frame, but there are periods of volatility where investment values may fall. By investing over years, you have more chance of these peaks and troughs smoothing out.
Usually, the longer you’ll be investing for, the more risk you can afford to take. However, a long time frame doesn’t automatically mean you should take a high amount of risk, and you still need to consider other factors.
3. What other assets do you hold?
Rather than seeing potential investments in isolation, it instead be helpful to look at them as part of your wider financial plan.
By assessing other assets and the risk they pose, you can create a balance across your plan that suits you. You may need to consider how your pension is invested, what cash savings you hold, or the value of property you own.
If you have a reliable income and assets that can provide long-term security, you may be in a position to take more investment risk.
4. What is your capacity for loss?
As all investments carry some risk, you might want to consider what would happen if your investment fell in value. How would it affect your short- and long-term plans?
No one wants to suffer an investment loss. Yet, knowing that you could absorb declines in value or volatility in the market is vital when assessing which opportunities are right for you.
If investment losses could have a significant effect on your lifestyle or mean you’d face financial challenges, you may want to consider alternatives to create financial stability first.
5. How do you feel about investment risk?
Finally, how you feel about risk is important too. Feeling comfortable with the investment you’re making and confident in your long-term plan is crucial.
Feeling nervous about investments can lead to you making decisions that could harm your wealth. For example, if the value of your investments fell during a period of short-term volatility, would you react and withdraw your money?
While this may seem like a way to minimise loss, volatility is part of investing and, historically, markets have delivered long-term results. Reacting is more likely to have a negative effect on your plans.
If you’re unsure about investments and risk, talking to a financial planner could put your mind at ease. Understanding how investments work and why they have selected certain investments for you can help you feel more confident, even when the market is experiencing volatility.
Contact us to create an investment portfolio that matches your risk profile
Balancing risk and return when investing can be difficult, but we’re here to help you. We’ll work with you to understand how to get the most out of your assets in a way that suits your risk profile and goals, including investing. We can also manage your investments on your behalf, so you can focus on what’s important to you.
Next month, read our blog to discover how to invest and the allowances you could use to reduce a potential tax bill.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.