Attitude to Risk

Investing your money by whatever method will always incur an element of risk. The level of risk will vary dependent on the nature of the investment. However, one person’s idea of what constitutes high risk may not be the same as that of another person. When determining your attitude to risk it is useful to take into account a set of factors. Firstly, the term over which you wish to make your investment and secondly, the rate of inflation. These are crucial considerations when deciding upon your attitude to risk.

Inflation may very well undergo short-term wild fluctuations but what is inevitable is that over the long-term it will evolve in an upward direction. As a rule of thumb the Rule of 72 is useful to bear in mind. If you divide the current inflation rate into 72 then you will be left with the number of years it will take for the value of your money to halve.

A low-risk investor may think he is opting for the safe bet and deposit his monies in a cash deposit account. If the funds remain in that account for a period of ten years, the investor will lose money simply because of the effects of inflation. The low risk approach in this instance is flawed because the result will be a guaranteed loss of money.

A medium- or high-risk investor may invest his monies in a shares portfolio over the same ten year period. Had the ten years suffered any bouts of high inflation these would have had a positive effect on the share price and so boosted the profits accrued.

This example is not intended to convert all those of you who believe in a low risk approach to go out and invest your monies in high-risk shares. The intention is to alert you to a more enlightened way of thinking, to transform your expectations of what may or may not happen to your investments into a more realistic interpretation of the situation.

The following categorisations represent the profiles of low- to high-risk investors and the types of typical investment areas they are likely to consider. There will inevitably be crossovers and the categorisations ought not to be viewed inflexibly. They are simply intended as a guideline.

Cautious investor - low risk

For investors who require that the capital they have invested is ‘best’ guaranteed not to devalue and who accept limits on access. This investor does not want to risk losing money.

Likely investment areas include cash deposit accounts, instant access bank or building society accounts, guaranteed income/growth bonds, pensioner bonds, National Savings investments and annuities. Investments in banks or building societies are subject to only certain levels of guarantee.

Cautious to balanced investor - low to medium risk

For investors who accept there may be some fluctuation in the value and growth of their investment. However, these would be limited by the guarantees built into the investment.

Examples of the types of investment suitable for this category are With Profit bonds, stock market linked bonds, Friendly Society bonds (With Profits), property funds, gilts, fixed interest and corporate bond funds.

Balanced investor - medium risk

For investors who are in a position to take a longer term view should early losses occur. Most of these types of investment will be aiming to achieve a rate of growth above inflation. This is only possible by taking a degree of risk that may, at times, mean that your investment is worth less than the original sum invested.

Suitable product areas will be Capital Investment bonds (managed), general (managed) Unit Trusts, ISAs (general funds), Distribution bonds.

Balanced to speculative investor - medium to high risk

For those investors who wish to invest in specific sector equity funds and who understand that likelihood of long-term growth is tempered by the possibility of short- to medium-term losses. The reasons for the risk are those of the balanced investor but the levels of both risk and return are potentially higher. The value of their investment may rise and fall and they may not get back the original sum invested.

Probable investment targets will be Capital Investment bonds (specialist funds), Unit Trusts (specific sector funds), investment trusts, ISAs (specialist funds), capital growth funds, currency funds.

Speculative investor - high risk

For the more adventurous investor who is prepared to expose some of his capital to high-risk investments. Speculative investors usually possess diversified portfolios and are familiar with the workings of the finance world. These investors must accept that there will be investments where a total loss will occur.

Most likely investment areas are shares, foreign currencies, options and derivatives, emerging market funds, venture capital trusts, property trusts and enterprise investment schemes.