Friday, March 9, 2012

Why "attitude to risk" is so important

Guest Post by John Hughes.
John Hughes writes for Best Bonds, a site that provides access to market-leading investment and savings bonds

The accurately gauging risk is crucial to developing an investment portfolio tailored to suit your needs. There are a wide range of investment types and an equally wide range of risks involved. The key to building your portfolio is to find a level of risk, or a combination of risk levels and types ideally suited to you.

What is the attitude to risk?

In short “attitude to risk” means the amount of risk you feel comfortable with taking in pursuit of higher returns. For some people this will be very little, for some a lot, it all depends on your individual circumstances and the degree of security you want for your money.

The greater the level of risk you are willing to take the higher your potential rate of return is likely to be.

Finding a level of risk that is right for you can be complex. Risks will vary widely across different asset classes, and it is also important to remember that  there are several different types of risk that you will need to consider including:

Capital risk: Technically speaking all types of investment will involve some degree of risk to your capital, how much will depend on the type of investment that you choose. That said, some types of investment such as the purchase of government bonds (gilts) will involve almost no risk at all, as the government is unlikely to go bust and default on their loans.

Other types of investment such as investing in stocks an shares can pose a high level of risk. Again, in return for this higher level of risk, you are also likely to see a greater potential for return.

If you invest through a high street bank or building society some or all of your capital may be protected by the Financial Services Compensation Scheme in the UK.

Specific risk: Your capital and returns may both be at risk if you invest in a particular company that subsequently performs poorly. If for example, the company that you have invested in goes bust you could lose some or all of your investment.  

Market risk: Likewise the performance of your investment may depend in part on the stock market performance of whatever country you are invested in. If the market of that country goes down, so too may the value of your investment.  
Inflation risk: While you may think that stashing your capital into a relatively safe savings account with a high street bank or building society is a risk-free option, the value of your capital may still fall if the interest rate that you are paid does not keep up with inflation after tax. What this means is that even the most seemingly safe option may also have some risk attached to it.

There are also other types of risk depending on the investments that you choose, such as currency risk (if the exchange rate fluctuates) if you invest abroad, or manage risk if you invest through an investment trust, for example.

Finding the right degree and combination of risk to suit you can be complex so you may want to employ the services of an investment advisor if you are unsure of any of the risks involved in any investment that you decide to make.

The best investment option for you will depend in large part on your attitude to risk. Whatever type of investment you choose to embark on, a thorough understanding of risk based on careful research can help you prepare a portfolio suited to your needs and circumstances.