What is investment risk?
Whether you are investing for a particular reason such as retirement, to generate an income or to simply to make your savings work as hard as possible, the two questions you are most likely to ask yourself before investing are: ‘what can I gain?’ (your potential reward) and ‘how much do I stand to lose?’ (your potential investment risk).
Independent, objective risk profiling is a key part of the Dynamic Planner service used by your financial planner. It is important for both investment selection and the ongoing management of your money.
But let’s start at the beginning – with investment risk and reward.
Risk & Reward
The Oxford English Dictionary states that one definition of risk is ‘the possibility of financial loss’ and defines reward as ‘to receive what one deserves’. As investors, we are generally much more concerned with how much money we could lose, than the amount we could gain, which means that assessing and managing risk forms a large part of the investment process.
Some of the most common investment risks are:
- Capital risk – the risk of not getting your money back
- Currency risk – the risk associated with investments invested in more than one currency
- Geographical risk – the risk associated with investing in more volatile or risky countries
- Inflation risk – the risk that your investment does not keep pace with inflation, making it worth less over time
- Interest rate risk – the risk of interest rate changes
- Market risk – the risk of gaining or losing money as share prices rise and fall
- Product risk – the risk that your investment changes and no longer meets your original requirements (this can happen if a fund objective changes to become less cautious, for example).
- Volatility risk – the extent and frequency that investments rise and fall (a highly volatile investment can vary significantly on a daily basis, for example)
In the face of so many potential pitfalls, choosing the right investment can be tricky, which is why so many people choose to rely on professional financial advice to help them.