What is Investment Risk?
Investment risk has a part to play in any investment you make whether it be big or small, and isn’t purely a negative thing, as higher risk can mean bigger gains. People often assume investment risk to mean nothing more than the potential that they’ll end up losing capital via an investment, but this is only one type of investment risk. Other risks include unpredictability and uncertainly over the amount of money you’ll actually make out of an investment. Assessing investment risk has a lot to do with figuring out your own attitudes to your finances and what kind of risks you’re willing to take – there’s a certain amount of subjectivity involved in the entire process.
Different Types of Risk
Capital risk is the most basic risk that you won’t get all of the money you’ve invested back. There’s a certain amount of capital risk involved in every investment you make, however some products are virtually risk free. National savings and government bonds are covered by the government so investing in these is pretty much risk free.
Inflation risk is the risk of inflation reducing the value of your money. This risk is most prevalent when you invest in saving accounts. Interest rates don’t necessarily correlate with rising inflation after tax, so even if you don’t spend any of your interest, the actual value of your savings decreases.
Shortfall risk is basically just investing too little or investing badly so you don’t actually make the returns you aim to. To reduce this risk you can invest some money for a higher return, but this will increase capital risk.
There’s a variety of risks related to the particular shares you invest in based on exchange rates, market and the actual success of the business you invest in. Find out more here.
How Much Risk Should You Take?
Figuring out how much risk you want to take is pivotal to creating a financial plan. The first thing to do is establish a real value goal. An investment calculator is a good starting point for this. From there you should speak to a financial adviser who will give you information about the level of risk you’ll have to take to achieve this goal. What you need to figure out on your own is how much risk you’re comfortable with taking, and this can often be to do with personality more than anything else. Once you’ve established the level of risk you’re willing to take a financial adviser can recommend how achievable your initial goal is.
A Few Guidelines:
If you want a higher return you’ll have to take a bigger risk. Bigger risk means more chance of losing all or some of your initial investment. If you’re looking for a long-term investment then you can generally afford to take higher risks as you can ride out economic fluctuations. If you’re looking to make a short-term investment then it’s better to avoid high capital risk.