Why taking too little investment risk could harm your goals

When you imagine the worries that might come with taking investment risk, it’s probably “taking too much” that comes to mind. After all, you’ve likely heard stories of people that have invested in high-risk opportunities and lost some or all their money.

However, when you’re investing for the long term, taking too little risk can also be damaging.

As inflation remains high, considering how you’ll get the most out of your money is more important than ever.

While interest rates are also rising, they still remain far below inflation, which was 10.1% in the 12 months to July 2022. As a result, money held in a cash account is likely to be falling in value in real terms. So, you may be wondering if investing could provide you with a way to maintain or grow the value of your assets.

One important thing to consider is: how much investment risk should you take?

Too little risk could mean your money isn’t working as hard

All investments carry some risk. However, investment opportunities can have very different risk levels. So, it’s vital you understand what risk you’re taking and whether it’s appropriate for you.

It’s natural to feel risk-averse when you’re making decisions. After all, no one wants the value of their assets to fall, or you may worry about what would happen if you lost the wealth invested.

Yet, if you’re taking too little risk, it could mean your money isn’t working as hard as it could be. As a general rule, the more risk you take, the higher the potential returns. So, taking an appropriate amount of risk could help you grow your wealth and reach your goals.

While markets experience volatility, historically, they have recovered, although this cannot be guaranteed. Taking a long-term view of your investments and the risk taken can reduce worries that you may have.

There are steps you can take to give you confidence when investing too. For example, you should have an emergency fund that you can fall back on. This could provide a valuable safety net if the value of your investments fell.

That’s not to say you should take a high level of risk for the chance of securing higher returns – it’s about balance. There are several factors you should consider when reviewing your investment risk profile.

4 essential factors to consider when creating a risk profile

A risk profile can help you understand what level of risk you should take. Within your investment portfolio, you’re likely to have investments with different levels of risk. However, overall you should align your portfolio with your profile.

Here are four key things you should consider when creating a risk profile.

1. The investment time frame

You should always invest with a minimum five-year time frame. This provides time for the peaks and troughs of the investment market to smooth out and, hopefully, deliver returns.

However, there are many situations where you’ll be investing for much longer. You may be investing for your retirement over several decades, for example. A rule of thumb is that the longer you invest, the more risk you can afford to take. So, it’s important to set out an investment time frame from the outset.

2. Your investment goals

What are your reasons for investing? Your response could change what investment risk is appropriate for you.

Let’s say you have a defined benefit (DB) pension that will provide you with a comfortable lifestyle in retirement. You want to invest so you can have more luxury experiences, such as long-haul holidays. You would be in a better position to take more investment risk than someone who is investing to create a retirement income that will pay for essentials.

3. Your financial circumstances

You shouldn’t make investment decisions without looking at your wider financial circumstances. If you’re in a secure financial position, you may be able to take a greater amount of risk, as volatility is less likely to affect your lifestyle.

Ideally, you should have an emergency fund in place before you invest. You may also want to consider other steps, such as financial protection, to ensure you’re financially secure.

4. Your attitude to risk

Finally, it’s important you feel comfortable and confident about the steps you’re taking, so your attitude to risk matters.

Talking to a professional about your options and the potential risks can put your mind at ease. Once you understand how investing could fit into your portfolio, it may be something you decide to move forward with, or you may consider alternatives.

It can be difficult to understand how much investment risk is appropriate for you, so we’re here to help. Whether you don’t know where to start or you’d like a professional to review your existing portfolio, please contact us to arrange a meeting.