When we talk about risk as an investment concept, we refer to the likelihood of losing money. We can’t control the financial markets, but we can manage risk by deciding how much to invest in different asset classes.

This decision is not the same for everyone. A client on the verge of retirement is likely to be less accepting of risk than someone in their twenties who is just starting to invest. Even two clients in broadly the same financial situation may have vastly different attitudes and tolerances.

A key step in building a financial portfolio is establishing how you feel about risk. As investment professionals, we help our clients assess how they feel about risk. For some, the best way to do this is a simple conversation, and in other cases, we use a questionnaire approach developed by leading behavioural scientists from Oxford University.

Below are examples of some questions that can help you determine your attitude to risk in the context of investing.

• How much risk have you taken in the past with your financial decisions?
• Are you prepared to lose money in the short term if there is a chance of making more money in the longer term?
• How would you feel emotionally if you lost money? 
• When you invest money, do you feel more excited about the potential gains or worried about the potential losses?
• Do you believe you need to invest in high-risk assets to achieve high returns?
• If you could choose between a low, guaranteed steady return or the possibility of making higher returns but with no guarantees, which would you choose?
• If all of your money was held in a bank account, would you feel safe and secure, or like you were missing out on something more?

Risk tolerance is very personal and does not always reflect the reality of your situation. It helps us understand how you feel about risk from an emotional perspective. There are a few other factors we would need to consider before recommending a suitable portfolio:

Knowledge & Experience

While an inexperienced investor may feel perfectly happy with the concept of risk, the reality may be different if they are seeing their funds lose money for the first time. Certain high-risk investments may only be suitable for experienced investors who can cope with potentially high losses. 

Capacity for Loss

Again, you may be comfortable with the concept of risk and reward and being an extremely confident and knowledgeable investor. Does this mean that a high-risk investment is the best course of action? It depends. Where there is a risk of loss, it is important to understand how this could affect you from a practical point of view. When considering capacity for loss, the following questions are also relevant:

• When is the money required? If you don’t need the money for another ten years, you have a higher capacity for loss than someone who needs the money now. 
• What other assets do you have? If the investment in question is a small proportion of your overall wealth, you could potentially afford higher losses than someone completely reliant on one investment. 
• What other sources of income do you have? If you are still working, own rental properties, or if you have a defined benefit pension scheme, you may be less reliant on your investments. 
• Do you have any liabilities or dependents? If you have other priorities for your money, your capacity for loss may be lower than someone without any commitments.

Requirement for Growth

It is also worth considering the risk level you must take to achieve your goals. If you can achieve your personal aspirations simply from a return that keeps pace with inflation, do you want to risk what you have in pursuit of speculative gains? There is no wrong answer here, but it is a necessary conversation.

Alternatively, a young and inexperienced investor may need to think about taking higher risks than they are comfortable with to provide the best chance of achieving their goals. Time is on their side, as history has shown that while equities can be volatile, they offer significant growth potential over a long investment term.

Please don’t hesitate to contact us if you would like to discuss your investment options. 

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Important Information

The contents of this article are for information purposes only and do not constitute advice or a personal recommendation. Investors are advised to seek professional advice before entering into any investment arrangements.

Please also note that the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.