5 useful tips for managing risk when investing

In recent months, there has been a surge of interest in investing. While it can be a good way to grow your wealth, it’s also important to manage your risk so that you aren’t impacted if the value of your portfolio was to fall.

According to a recent survey by the Financial Conduct Authority, reported in the Telegraph, nearly two-thirds of young investors said a large financial loss would have a significant impact on their lifestyle.

If this is true for you, it’s important to manage your risk to avoid such losses. Read on for five useful tips for managing risk when investing.

1. Determine your tolerance to risk

Whenever you invest, there will always be some element of risk so it’s important to know how much you are willing to tolerate. Generally, when there is a higher level of risk on an investment, there is a greater level of potential reward too.

For example, a low-risk investment may be something like a government-issued bond, known as a “gilt”. When you buy a gilt, you can be sure of getting your money back, but you will typically not make much in return.

On the other hand, a high-risk investment might be something like buying company shares. Here, there is the potential for their value to sharply increase if the company does well, allowing you to sell at a profit. However, if the company struggles and the value of the shares fall, you could lose money.

As a rule, most investments can be simplified into three categories:

  • Low-risk investments are unlikely to fall in value but also typically offer low returns, which are not likely to grow much more than the rate of inflation.
  • Medium-risk investments have a good long-term potential for growing your wealth but have a higher risk of making a loss.
  • High-risk investments can be highly profitable if the risk pays off but also have a significant chance of losing your investment.

Tip: Consider how much risk you would be willing to take before you start investing. If you aren’t sure then you may benefit from seeking professional advice.

2. Diversify your investments

When you invest, you’ll notice that there are plenty of options to choose from but an easy mistake to make is thinking that you only need to choose one.

If you want to mitigate some of the risk, it can be a good idea to invest in several different asset classes in different sectors. This is called “diversification”.

Diversifying your investments means that if one market that you’ve invested in takes a fall, only a portion of your portfolio will be affected. Even if some of your investments fall in value, others may see growth.

Tip: Consider investing in a variety of asset classes so that you aren’t overexposed in one area.

3. Invest for the long term

If you’re looking to invest, it typically pays to take a long-term approach.

Short-term volatility can have a big impact on stock markets and can mean that your investments temporarily fall in value. That’s why if you’re thinking of investing, you should aim to do so for at least five years.

You can see the reason for this in the data from 1970 onwards from the MSCI World Index, which is a basket of more than 1,600 companies from across 23 developed countries.

Source: Tilney

As you can see, the index shows that since 1970, the highest annual return on a short-term investment (of only one year) was 56% but the lowest was a fall of 30%. However, on an investment period of ten years, the highest return was 24% but the lowest was only 0.21%.

As you can see from these figures, while the highest average return may have been lower, the risk to the investor was significantly reduced when investing in the long term.

Tip: Only commit to investing in the stock market if you’re willing to commit for five years or more.

4. Search the market for a reasonable investment charge

Typically, many investment products have charges associated with them. That’s why it’s important to consider these charges when deciding how and where to invest.

The difference between charges may appear small but this isn’t necessarily the case. Over the long term, even a small difference in percentage charges can add up and eat into your investment by a considerable amount.

If you want to maximise your returns, it’s important to compare charges between investment products to find the best one for you.

Tip: Check the charges on investments that you’re considering to estimate the effects they may have on your returns.

5. Seek professional advice

If you’re serious about using investing to grow your wealth, you may benefit from working with a financial adviser who can draw on experience when making decisions. This can help prevent you from making amateur mistakes that could be avoided.

A financial adviser can help you to consider issues such as your long-term financial goals, your risk tolerance, and how long you should commit for. They can also help you to maximise the tax-efficiency of your investments.

Tip: Work with a financial professional to tailor your investment strategy to your financial situation and long-term goals.

Get in touch

If you think you would benefit from advice when building a robust investment portfolio, we can help. Email enquire@london-money.co.uk or call us at 0207 808 4120 to find out more.

 

Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.