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How much risk are you willing to take with your money?

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Summary

Three types of risk involved in investing – including one you may not have thought about.

2 min read

All types of investing come with an element of risk but there is an important flip side – the chance of a higher reward.

This means that, although risk should always be considered carefully, it is not necessarily something to avoid. The important thing is to understand how much risk you are willing to take and how much loss you could potentially afford to absorb.

But there are a number of day-to-day risks that investors seek to minimise in many ways. Here are just three of them.
 

1) Inflation risk

Common wisdom is that cash in a savings or deposit account is safe. Unfortunately, it’s not as simple as that. Inflation can quietly erode its value every day.

As Sven Balzer, Head of Investment Strategy, explains: “Investors talk about ‘nominal’ value versus ‘real’ value. The nominal value of £10 doesn’t change – it’s always £10. But what that translates to in the real world changes as prices shift. If prices rise, the ‘real’ value of your money tends to fall because that same £10 doesn’t go as far as it used to.

“One potential way around this is to find ways to make a bigger return on your cash, like investing. A savings account has its merits, including greater security, but it’s not necessarily keeping up with rising prices. We wouldn’t necessarily advocate swapping one for the other, but a combination of the two can help in an inflationary environment.”

It’s always worth remembering, however, that investments can go down as well as up and it’s possible you won’t get back the amount you put in. Which brings us to risk number two…

 

2) EQUITY RISK

Equity risk relates to the ups and downs of share prices on the stock market – financial markets are unpredictable and nothing is guaranteed.

There are many elements affecting equity risk and some shares are inherently riskier than others. But this doesn’t automatically make them unattractive.

While a lower-risk investment means you’re likely to lose less when markets drop, you’re also generally likely to gain less as markets rise. On the other hand, a riskier investment amplifies the effect of market movements, so you do better in good times but worse when markets turn.

“A savings account has its merits, including greater security, but it’s not necessarily helping when it comes to keeping up with rising prices.”
Sven Balzer, Head of Investment Strategy

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3) Bond risk

Bonds are generally considered safer than shares but they come with their own risks, including default risk. When investors buy bonds, they lend money to the issuer in return for regular interest payments and the repayment of the original sum when it expires. Default risk represents the danger that a government or company fails to pay back this debt.

This is far less likely with governments, which is why government bonds are considered a very low risk investment but also why they pay very low returns.

Interest rates can also affect bonds. As interest rates rise, bonds already held by an investor become less attractive because the returns they offer become lower than what’s widely available.


Is there a ‘right’ risk mix?

At Coutts we work to mitigate day-to-day risk in a number of ways. Each client’s financial circumstances, goals, and risk appetite will vary, but there are some key principles we apply across our process.

One of them is diversification, examples of which include:

  • adopting a mix of shares and bonds – clients who want more risk will typically seek a higher allocation to shares over bonds, and vice versa
  • using sector and regional variation – holding assets across a range of sectors and in different countries could potentially help maximise reward and shield against loss
  • having alternative investments such as commercial property in our portfolios

Different approaches also allow us to offer investments that match different attitudes to risk. For example, there are five Coutts Personal Portfolio Funds for those who want to invest simply online, each with its own risk profile.

Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

From skiing to cycling to crossing the street, risk is a part of everyday life. And it’s no different when investing. But if you understand the risks and have a clear idea of your tolerance for them, you can take measures to keep them at acceptable levels. At Coutts we adopt a number of measures to mitigate risk and provide our clients with options to match their appetite for it.

About Coutts Investments

With unstinting focus on client objectives and capital preservation, Coutts Investments provide high-touch investment expertise that centres on diversified solutions and a service-led approach to portfolio management. Our investment process is as disciplined as it is creative – ensuring tailored solutions with robust results.

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