Everything you need to know about the different types of risks you’ll face when investing as well as how to prevent being taken advantage of by con artists is included in this guide.
Why is the risk of an investment so significant?
It is essential to have a solid grasp of risk, regardless of whether you are investing with a specific objective in mind or simply putting money away for retirement.
Specifically, you need to comprehend how you personally feel about taking risks.
Some people are content to take calculated risks if it means the possibility of a larger return in the long run, whereas others will avoid situations in which they stand to suffer a financial loss at all costs. However, if you avoid taking any risks at all costs, this could end up costing you money.
In this section, we will discuss the many sorts of risks, whether or not you should be concerned, and the actions that you may take.
What kind of risk are you taking with your money?
There is no such thing as a completely risk-free asset, but different assets come with varying dangers and opportunities for gain. If your investment portfolio is comprised of a greater proportion of risky assets, you should anticipate greater volatility in the portfolio’s overall value.
Cash carries the lowest risk of the four options, but because it often produces poor returns, the value of your money may be diminished over time as a result of inflation (for more information on this topic, see the section on “Inflation risk”).
Government bonds, often known as gilts, are the first rung on the risk ladder, followed by investment-grade corporate bonds. With investment-grade corporate bonds, you are essentially lending money to huge corporations in exchange for a predetermined rate of interest.
Significant-yield bonds, which are commonly referred to as “junk bonds,” are an even riskier option because they deal with corporations that are perceived to have a high risk of defaulting on their debt.
Shares, which are often referred to as stocks or equities, are considered to be one of the riskiest assets because stock markets are notoriously difficult to anticipate. However, certain markets are regarded as being riskier than others.
Investing in developed markets like the United Kingdom and the United States is considered to be a relatively safe bet when compared to investing in other equity markets, despite the fact that these developed markets also have their fair share of higher risk options. On the other hand, the equities of emerging markets like Brazil, China, and India are likely to be more volatile.
Investing in places of the world that are visited by fewer investors can be a costly endeavour because the local stock markets may be more volatile and less liquid.
Golden and silver bullion
Gold has traditionally been viewed as a safe haven due to the fact that its price has a tendency to rise when stock markets are experiencing difficulties.
However, there is a possibility that gold prices may go down, gold does not pay dividends, and you will have to pay fees in order to hold actual gold (funds that invest in gold are also available).
Silver is more prone to price fluctuations, which can be bigger, and it also has negatives that are comparable to those of gold.
Your money can grow through rental income and growth in the value of the property you own when you invest in commercial property, such as offices, supermarkets, and warehouses; however, investing in commercial property can be illiquid, which means that it can be difficult to sell if you need to access your money quickly.
You may invest in almost any kind of commodity imaginable, from crude oil to cereals to copper, and the list is virtually endless.
Many people choose to invest their money through exchange-traded commodity funds rather than directly purchasing commodities because it is typically impossible to do so. Investing in companies that extract commodities is another strategy, which allows you to profit indirectly from increases in commodity prices.
As a general rule, commodities belong to the category of assets that are very volatile, and as a result, they are not necessarily appropriate for novice investors.
Bitcoin is only one example of the many cryptocurrencies now in existence.
The prices of cryptocurrencies have been extraordinarily volatile in recent years, increasing and decreasing in a short space of time. As a result, cryptocurrencies cannot be regarded as a low-risk asset because of this trend.
Investing in cryptocurrencies is not protected by the Financial Services Compensation Scheme, and investors frequently fall victim to frauds.
What else makes an investment risky?
In addition to the risks that are inherent to the assets themselves, investors should also take into account the following risks:
The danger of inflation refers to the possibility that rising prices will make your money less valuable over time.
If you are already retired, this might present a particularly difficult challenge for you, as the purchasing power of your funds, which you have worked so hard to accumulate, will erode over time.
Because there are very few savings accounts that offer interest rates that are competitive with inflation, mitigating the risk of inflation may require accepting some level of risk in order to participate in the investment market.
When you invest in individual company shares, there is always the possibility that unanticipated occurrences will cause your portfolio to become worthless. Although some share prices will move more than others, no company is entirely safe from the effects of market volatility.
Diversification is essential for minimising the impact of any one type of investment risk.
Investing in pooled investment funds, such as investment trusts or unit trusts, is the greatest and most cost-effective approach to distribute your risk among multiple investments. Pooled investments get their name from the fact that investors combine their funds with those of other savers in order to purchase a variety of different stocks.
When a whole stock market starts to plummet, this is an example of market risk.
Even if the prospects for certain industries or firms remain the same, share values may begin to decrease across the board if public opinion begins to shift against shares of a particular country, such as the United Kingdom.
You can reduce your exposure to market risk by investing your money in stages over a period of at least five years, which will give your investments sufficient time to recoup their losses.
You can lower your exposure to market risk by investing in a diverse range of stock markets located in different countries.
Risk associated with currencies
You put yourself at risk of currency loss if you invest your money in stock markets that are located outside of the UK. When you want to withdraw your money, it will first have to be changed into sterling regardless of where it is currently invested. As a consequence of this, shifts in the value of your investment will be impacted by changes in the exchange rate, which may either work in your favour or to your disadvantage.
You can reduce the risk of currency fluctuations by diversifying your holdings, such as through the use of an international fund that disperses its investments across the world, or by hedging your position, which means investing in investments related to currencies in order to guarantee that you will never lose additional money as a result of shifts in the value of the currency.
Hedging is handled for you by certain funds that invest in foreign markets. You can reduce your exposure to currency risk by remaining in the UK, but doing so will raise the risk you face in the market.
The level of success that individual managers of unit and investment trusts achieve with their portfolios might vary greatly from one another.
It is therefore quite challenging to choose the best fund managers, despite the fact that some of the greatest fund managers may routinely outperform their benchmarks and offer the kind of returns that you are hoping for.
Investing in a fund that tracks an index rather than selecting a management should eliminate the need to worry about selecting a poor manager because these funds simply replicate the performance of their chosen index. Index trackers, as opposed to funds whose managers attempt to outperform the market, typically have lower management fees.
What steps can I take to reduce the risk of my investments?
If you want a higher return on your investment, you will typically have to accept a higher level of risk.
When you make investments with a higher degree of risk, there is a larger possibility that you will lose some or all of the money you initially invested (your capital). It is prudent to avoid taking on too much financial risk if you are planning to save for the short term (less than five years).
Investing in share-based assets has historically been shown to be the best strategy to provide growth that is greater than the rate of inflation over the course of a lengthy period of time. There is a possibility of loss, but if you spread out your investments over a longer period of time, you have more time to make up for any losses incurred as a result of a decline in the stock market.
When you diversify your holdings, the ups and downs in the value of any individual item will have less of an effect on your overall results.
That entails making investments in a diverse range of assets, dispersed across a variety of countries and sectors of the economy.
How can I get my investing portfolio back in balance?
It is likely that your priorities or your willingness to take risks will shift, and as a result, your investment portfolio may need to be modified to reflect these shifts.
However, as a general rule, you should reevaluate and rebalance your portfolio on an annual basis. The process of rebalancing entails selling or purchasing assets, reestablishing the proportions of asset types that existed in the beginning, and ensuring that you are not exposing yourself to a greater level of risk than you had anticipated.
This is important because, over time, your investments may fall out of sync with your initial asset allocation; this tends to happen when one asset, typically stocks, increase more quickly than the others. The reason for this is that your asset allocation was originally determined.
If you work with a financial advisor, they will rebalance your investment portfolio on your behalf. Rebalancing is handled by several investment platforms that also provide managed portfolios as an option for investors.
Investments that are not doing well
In general, you should also review the performance of your investments and give some thought to the possibility of selling long-term assets that are underperforming.
But resist the urge to sell in a rash; doing so is likely to result in losses and cause you to miss out on any potential gains that may have been made.
It is important to fight the urge to fiddle with your investment portfolio; instead, you should seek to rebalance it every six months or a year. The number of financial platforms that offer mobile apps for smartphones is growing, but using these apps comes with the risk of being tempted to make unnecessary trades.
How can I recognise a fraudulent investment opportunity?
Don’t let yourself become one of the investors who lose tens of millions of pounds every year to frauds; avoid becoming a victim yourself.
These include both outright cons, in which you send money that is never received again, and schemes, in which the real assets, fees, or amount of risk are not revealed until after you have already invested.
Scam artists frequently concentrate their efforts on specific categories of assets, such as cryptocurrencies and unusual commodities. Be wary of ‘clone firm’ scams as well, which include investors imitating actual businesses by proposing investments that are already familiar to you.
Always consider the following points before putting money into an investment:
Examine the warning list maintained by the Financial Conduct Authority.
Verify that the company is listed on the Financial Services Register; ensure that the permissions listed for the company on the register correspond to the service you are being given; use the contact details listed on the register to ensure that you are dealing with the actual company;
Investigate whether or not you are covered by the Financial Services Compensation Scheme or the Financial Ombudsman Service.