5 key facts about balancing risk and reward when you’re investing

Category: News & United Kingdom

The value of your investments, in particular your pension fund, is crucial to the success of your financial planning.

That means a key factor when it comes to retirement planning is balancing the amount of risk you’re prepared to accept against the growth required on your investments to meet your financial goals.

Here are five key facts about investment risk, and balancing risk and reward, that you should consider when you’re investing your money.

1. You can manage risk

In simple terms, “risk” is the downside you must be prepared to accept to get the required returns you need on your investments.

There are various levels of investment risk, and different ways you can manage your investment strategy to reduce the level of risk to your money.

You will often see investment risk expressed on a scale of 1 to 10. Risk rating one will be leaving the money in a cash deposit account where the value won’t go down, but where you’ll see precious little growth – especially given the current low rates of interest being paid.

Risk rating 10 will be in an ultra-high-risk investment where there may be an equal chance of losing your money as seeing a strong return.

All investments fall between those two ends of the spectrum. Your attitude to risk will be a key factor in how you invest your money.

2. It’s inevitable that the value of your investments will rise and fall

The nature of stock markets means that they rise and fall. Accepting that fact is integral to understanding risk and a key step towards long-term investment success.

You just need to look at a simple chart of the FTSE100 over the last 10 years to see the amount of fluctuation there is in stock markets.

Source – Google.com

The more risk you accept when you’re investing, the more chance you have of increased returns. But, against that, by taking on more risk you’re increasing the chances of fluctuation in the value of your holdings.

If you want the value of your money to increase at a better rate than the low rates of interest currently being paid on savings accounts, you should consider investing it.

3. There are ways to mitigate market volatility

It may sound counter-intuitive, but volatility can be a good thing, rather than something for you to fear.

This is because, when markets fall, you can often buy more stocks as the price will be lower. This can increase your chances of growth.

Regular contributions into investments such as your pension fund can be effective. If and when markets fall, you’re buying assets at a cheaper price.

You can also reduce the impact of volatility by ensuring you reinvest dividends. Simple accumulation tracker funds will do this automatically. For example, the FTSE100 has produced annualised returns of 6.5% over the 10 years shown in the above chart.

This illustrates another way of mitigating market volatility – investing over the long term rather than for short periods.

4. When it comes to investing, you can sometimes be your own worst enemy

By leaving your investments to grow over an extended period, you’re more likely to be successful than if you react to every market movement.

By panicking and continually adjusting your investment holdings and selling investments at a lower price than you paid for them when markets fall, you’ll be crystallising losses and losing capital.

One of the most common investment adages you’ll hear is “time in the market, not timing the market.”

This means that it’s difficult to buy and sell investments at the right time to maximise your profits. You’re more likely to achieve consistent returns by simply keeping your money invested over a longer period.

By tuning out the daily noise and effectively ignoring your portfolio, you’ll allow markets to do what they have always done and recover from falls and show potential long-term growth over extended periods.

5. There’s no “one-size-fits-all” attitude to risk

Remember, everyone’s risk tolerance is different. Some people are naturally more cautious than others.

The secret is finding a balance between what you’re comfortable with and what you need to achieve the required investment returns to meet your goals.

Being realistic about what you’re expecting to gain might help you work out the kind of risk you’d have to take on to get there and whether you’ll have to adjust your expectations.

People express pleasant surprise when they realise how much their family home has appreciated in value, but that’s because you tend not to get your house valued every couple of months as you can do with your investment funds.

By ignoring the value of your pension and just keeping on paying in as much as you can afford, it’s likely you’ll be as equally surprised by the growth in value as someone finding out the current value of their house.

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At bdhSterling, we have a wealth of experience in helping clients put together an investment strategy to help achieve their financial aims.

Get in touch to find out how we can help you.