Understand the balance between risk and return, and learn how to get an idea of your own risk profile.
1. What is the balance between risk and return?
2. How do I know my risk profile?
There are two sides to the investment coin: risk and return.
Investors will always want to maximise their return, but they must also have an eye on the risk. If the potential risk of loss is too high, then the potential return may not be worth it.
There is no ideal balance between risk and return, as everyone has a different attitude to risk. This will vary according to personality, goals and circumstances.
For example, someone who wants to grow the value of their capital as quickly as possible will have a different view of risk than someone whose priority is to defend the value of the capital they already have.
Different risk profiles should result in different investment strategies, so it’s important that you consult a financial adviser about your own attitude to risk, which investments are appropriate for it and what impact it could have on your investments.
You will always hope to make a profit on an investment, but there’s no guarantee of that happening. Even with an investment which has performed well in the past, you could lose all or part of your money.
Knowing your risk profile is the first step in making better investment choices. Finding a good balance between risk and return depends on your personality, goals and circumstances.
You should always consider speaking to an independent financial advisor, so they can assess your risk profile and make appropriate recommendations. But, to get started on understanding your risk profile, you should follow these steps;
Calculate what you can afford to lose
Ask yourself what would happen if you lost some, or all, of the money you intend on investing.
Take into consideration your financial commitments, and make sure you wouldn't be putting yourself into financial difficulty if you were to experience any losses.
Know your goals and timescales
Knowing your goals and timescales is crucial.
If you have short-term goals, you will most likely want to take as little risk as possible - without making your goals impossible to achieve. You will need your money to be relatively easily accessible, and you will not have time to wait for falls in value to recover.
However, if you have longer-term goals - such as saving for retirement - you may be open to taking more risk for the possibility of higher returns. Your investments will also have more time to recover from falls in value.
Determine your attitude to risk
Most people don't like the thought of losing money, but some are generally more open to risk, while others are very cautious.
You must figure out how much risk you feel comfortable with, and base your investment choices around this.