What Do We Mean By “Investment Risk”?
What Do We Mean By “Investment Risk”
By Chris De Luca
“No (battle) plan survives contact with the enemy”
This was a quote from Napoleon which still rings very true today, especially when we consider the mayhem caused by Covid-19. The global economy has been turned upside down, as has life for millions of us, demonstrating the importance of building resilience into our planning and investment strategies. The impact of the various types of investment risk will test this resilience.
When we talk about an investment, most people usually think of an ISA, pension, or buying a property, but whatever it is, the same principles apply:
- You usually give money, but this could also be your time or possibly guarantees (or contacts) to someone whose role is to provide you with a return, now or in the future, in the form of an income or a capital sum – or both.
- There is invariably a cost to acquiring/maintaining and growing this asset – paid by you directly or by the person/firm managing the investment.
- When the funds are required, you disinvest, either the whole amount in one go or over a period of time, or you take a regular income.
A key part of my role as a financial adviser is to help my clients manage their expectations and to provide them with as much information as possible, so they can make truly informed decisions. However, it’s important to remember there is no guarantee that, whatever we set out to do, will succeed. When it comes to risk, it’s crucial an investor is comfortable with their chosen investment. a significant reason why we have seen a huge growth in the environmental, social, governance and allied sectors.
The majority of most types of investment are fine for the right people, for the right reasons, at the right time. All three ‘rights’ are needed to avoid disappointment – despite what Meatloaf may sing! And that is why my clients, many of whom have been with me for many years so have experienced market crashes, have been able to remain resolute.
The first risk factor to consider, which can apply to all forms of investment, is Confirmation Bias. Nowadays, this is endemic in all walks of life; we tend to instinctively believe anything which conforms to our values and beliefs and instinctively discount anything that does not – ‘fake news’ in other words. But this bias means we run the risk of falling foul of one or more of the various ‘Sod’s Laws’ that I have referenced in my recent LinkedIn posts and on the website.
One of the first questions to clarify is what’s the difference between ‘savings’ and ‘investments’? The terms can be interchangeable, but they can mean different things to different people, both psychologically and emotionally. As an example, a savings pot could be for an emergency reserve or specific foreseen calls on capital in the near future (for example – a holiday, a car or planned work on the house). So, you would probably want to be very certain of the amount available at any point.
Funds being invested for more long-term, less precise goals – e.g. ‘retirement’ – can entertain more volatility if the end result is to beat inflation over longer timeframes. It is important for people to really understand this difference to avoid making short-term investment decisions, which could end up disrupting or defeating their long-term aims.
[h2] Specific types of investment risk
Volatility – most people are familiar with stock markets rising and falling but the consequences of this do vary considerably depending on the time that can be afforded for recovery, which is why stock market investments should really have five year plus timeframes as a minimum.
Liquidity – if you need to get your money out unexpectedly, can you? This is a big drawback to owning actual property or property funds, which we have seen frozen since the pandemic hit the UK. This type of risk is also associated with property development projects or investing into, often start-up, businesses either directly or using the crowdfunding model.
Credit or creditworthiness – sometimes even good business ventures can go to the wall. Lines of credit can disappear without warning or good reason. Unforeseen events, e.g. the pandemic, can stop well-run businesses dead in their tracks, never mind the poor ones. And there are the charlatans, covered in more detail by the ‘Laws of Sod’.
Inflation – although currently low at the time of writing this article, this is not going to last forever. If the growth of your capital is not beating inflation, it is losing value in today’s terms. If your income returns are fixed, then inflation will reduce buying power, especially over longer time frames.
Politics – which is having as great an impact as I can remember. Governments have always tinkered with the tax system to pay for running the country and that will be especially true now with all the financial support that has been given. Pension and other tax reliefs right across the board are in the firing line. And we have the increasing prospect of trade wars around the world for all sorts of reasons – a point of discussion for another time!
Currency – this can increase or decrease your buying power in a very short space of time as ex-pats, having a UK Sterling pension, have found to their cost. For UK investors to create the diverse portfolios they should have to reduce their overall risk, investing in companies abroad is necessary but, alongside this, investment managers should be hedging against potentially significant currency swings.
Charges-only focus – if the investment decision is only based on the charges quoted, then the investor can lose out. The Victorian philosopher and philanthropist, John Ruskin, famously said “if you deal with the lowest bidder, it is well to add something for the risk you run, and if you do that you will have enough to pay for something better.” Is it better to have an 8% growth with 2% charges or 6% growth and a charge of 1%? Don’t mistake me, charge considerations are important but, like the tax tail, they shouldn’t wag the investment dog. The real concern with charges and penalties is if they are hidden.
There are others that we could mention, but the above are the main ones your adviser should be factoring into any specific recommendation. But, regardless of whether or not you have an open mind, any financial plan needs a fail-safe mechanism.
For further advice on investment risk and strategy, get in touch to speak to our team. Juniper Financial Management provides practical advice on a wide range of investments and our first meeting is free with no obligation