It hasn’t been an easy ride for people with savings. The best one can expect in a deposit account today without tying one’s money up for years is just over 1% per annum. But with real-world (CPI) inflation running at around 2%, your savings are depreciating! This phenomenon is forcing many savers who would never normally contemplate anything outside a deposit account to consider risk-based investments, such as stocks and shares ISAs.
What’s the alternative? Is there such a thing as an investment that carries no investment risk but gives a return higher than inflation without a long term tie up commitment? Please get in touch if you know of such a thing. If you’re like the rest of us, perhaps it’s time to accept that getting a return on your money may involve taking some investment risk. It is, therefore, important that we discuss the subject and try to understand what investment risk is all about.
Risk is the probability or threat of loss, and dreading investment risk can cause paralysis and procrastination, both of which get you nowhere. The truth is that all investments, even deposits, carry some degree of investment risk. For example, if the money in your deposit account is depreciating, it is losing money, which is exactly what people who try to avoid investment risk are afraid of.
There are a few things to think about before considering how much investment risk you want to take, such as how much you can afford to invest, how long you can be without the money you’ve invested, whether you want growth or income or both and the tax implications of your potential investment.
Will I lose money?
Many people think of investment risk in this way: “Am I likely to lose money and if so, how much?” To complete the picture, you should decide whether the safety of your money is a higher priority than growth. Or perhaps you are willing to accept a higher investment risk to achieve a higher return on only part of your money.
You can certainly find investments that guarantee that you won’t lose money, but there is always a price to pay for such guarantees. Typically, this would mean one or more of the following: giving up part of your growth, paying a capital guarantee fee, and keeping the capital invested for a specific period when the guarantee would apply.
The loss of sleep test
The elements that determine whether or not you achieve your investment goals would include the amount you’ve invested, the term, your rate of return after fees, taxes and inflation. If you cannot accept much investment risk in your investments, then you should expect a lower return. To compensate for the lower return, you may wish to consider investing more for longer.
Your comfort level with investment risk is essentially the “loss of sleep test.” If you’re losing sleep over it, you’re taking too much investment risk! Investment risk is a personal thing and there is no right or wrong answer. Arguably, younger people can take more investment risk than older people, however the converse may also be true as older people tend to have more money to invest than younger people.
Comfortable is not always profitable.
You may need to step out of your comfort zone to realise significant gains. Know the boundaries of your comfort zone and practice stepping out of it in small doses. If you want a return of more than 1%, you’ll need to take some investment risk. Paying for an expert to run your investments for you in a properly diversified portfolio may well be the answer and a price worth paying.