All investing involves risk and, as you know from Lesson 2, the stock market can rise and fall so you might get back less than you invested. However, over the long term, investing has historically beaten the returns of cash savings so it’s a great place to make your money work harder over time. 💰
Here’s what you need to know about the main risks of investing, including the five steps to help manage your investing risk and achieve your long-term financial goals.
What are the risks of investing?
One of the main risks of investing is that you might get back less money than you invested. This can be a hard thing to face, especially as a first-time investor. Based on factors like politics and economic conditions (which we learnt about in Lesson 2), there’s no guarantee that your investments will perform well in the future. That said, if you’re aware of the risks, you can take steps to manage them.
When people talk about low-risk investments, they’re usually talking about investments that offer small and steady returns in exchange for a lower chance of losing money. The general consensus is that cash funds and bonds are low-risk investments – cash funds because your money isn’t exposed to the ups and downs of the stock market; bonds because something would have to go badly wrong for a bond issuer to be unable to pay you back the amount you loaned them.
Even with low risk, there’s no such thing as a risk-free investment. All investing involves risk, but that’s the price you pay for the potential for higher returns, especially when compared to keeping your spare money in a bank account.
For high-risk investments, people accept a slightly higher chance of losing money in exchange for potentially higher returns. Asset classes like shares and property are higher risk than cash and bonds, but the returns they offer can be far more appealing to investors – especially over the long term. It’s important that you do your own research before investing.
How to manage your investing risk
Here are five steps to help manage your investing risk:
1. Do your own research 👨💻
Investing requires research. You wouldn’t buy a house without scouting out the area first, and you wouldn’t buy a car without making sure the engine worked.
If you’re investing in tracker funds, doing your research is relatively easy. You’ll need to check out the fund’s key investor information document (KIIDs) – which will tell you what the fund tracks, what the fund fees are and how risky it is, so you can make an informed decision on whether it’s right for you. You can access KIIDs for the funds that we offer in-app and on our funds page.
2. Consider your investment time horizon 🌅
Historically, the best investment returns have been made by investing for longer than five years. This gives your money more time to grow with the magic of compounding (we’ll focus on this in Lesson 7) and you’ll be able to ride out any stock market dips along the way.
Knowing your investment time horizon can also help you determine the level of risk that is appropriate for your goals. For example, if your financial goal is a long way in the future, you may have a higher risk tolerance. That’s because there’s more time for your investments to recover from corrections and crashes. Remember, spending time in the market is better than attempting to time the market – and, even when you’re investing for the long term, it’s important to keep a short-term cash supply on hand for emergencies.
3. Diversify your exposure 🌍
Diversifying your investments across a range of different asset classes and sectors means that you’re not putting all of your eggs into one basket. 🐣 Let’s say that you’re investing with a Stocks & Shares ISA into our ‘Balanced’ Starting Option – you’ll receive the following allocations:
- 65% global shares
- 10% global property shares
- 25% corporate bonds
Since you’ve diversified your exposure, if corporate bonds fall in value it’s less likely to affect the overall value of your Stocks & Shares ISA because you’ve got 75% of your allocation in another asset type (shares). By diversifying, you can help reduce your investment risk.
Some funds are more diversified than others. For example, an all-world tracker (like the Fidelity Index World fund) will be more diversified than a technology or healthcare tracker – so you should consider the risk profile of each fund – as well as the sector, country or countries it tracks – before you invest.
4. Review your investment allocations 🔎
Choosing an investment fund might not be a one-off decision. You should review your investments regularly (at least once a year) to make sure that your risk level is still right for your personal circumstances and goals in the current economic conditions.
5. Don’t act on your emotions 😄😟
Emotions can be your worst enemy when investing. If the market is falling, the natural impulse is to sell up and get out. But wait! Even though your instincts would tell you otherwise, as a long-term investor, getting out of the market can be the costliest mistake of all – especially if you’re selling up because markets are falling. Remember that JP Morgan study we mentioned in Lesson 2? It showed that over a 20-year period, seven of the 10 best days in the market (based on the S&P 500 index) occurred within 15 of the worst days.
Question one: Complete this sentence: investing offers better returns over the…
- … long term
- … medium term
- … short term
Question two: True or false: ‘when you’re investing, you could get back less than you initially invested’.
Question three: Complete this sentence: time spent in the market…
- …is better than attempting to time the market
- …is worse than attempting to time the market
Scroll down for the quiz answers.
🎓 Ready to tackle Lesson 6? Learn all about tax wrappers and how they can help grow your investments over time.
Question one: Long term
Question two: True
Question three: Is better than attempting to time the market
All investing should be regarded as long term (minimum five years) and historic performance isn’t a guarantee of future returns. The value of your investments can go up and down, and you may get back less than you invest. We don’t provide investing advice, and investors should make their own investment decisions or contact an independent adviser.