Welcome to High Edge Financial Planning, your local independent financial planning and advisory professionals and our column on issues relevant to financial planning and advice.
Investment and Risk
We’ve gone through some testing times in the last few years: banks collapsing, credit crunch, stock markets falling and then bouncing back. What is one to do when it comes to investing money? If you ask anyone what they would like from an investment the typical response is ‘no risk and a big return’! Utopia!
However, all investments and savings are exposed to one or more forms of risk and it is true to say that by taking increasingly more risk you can achieve a better return over the longer term.
Term: why is that important? Well, depending on your investment horizon (the period over which you are prepared to invest), it will dictate the type of asset you may consider for the investment. As a rule of thumb, if your investment horizon is under 5 years, you would generally be better off investing in deposits with a bank or building society. This is because if you need the money in the short term you would not want to expose yourself to the risk of not being able to access it, or getting back less than you have invested due to asset price movements.
When investing for 5 years and beyond you open up other investment possibilities. The traditional asset classes are: cash, bonds, property and equities. Each carries a different level of risk and within each asset class you can access different levels of risk. A key consideration for the investor is that of risk and return, and capacity for loss. For instance, you could build a portfolio of shares yourself, but that can carry a high degree of risk, as you are relying on your own experience and research capabilities to select the right stocks.
There are also different types of risk. Inflation risk is a particular issue right now as cash deposits are paying low rates, whilst inflation is higher. Your money is therefore losing value in real terms.
There is market risk. This is where your investment is subject to the ups and downs of the markets. This could be the stock market.
Concentration risk is where you may have all your cash in only one or two asset classes or investment funds. A way to tackle this issue is to diversify your investment. This means to invest varying percentages in different funds and asset classes to spread the risk and also the return (the not having all your eggs in one basket principle).
Counterparty risk is typically found in what are called ‘structured products’. These are products which aim to provide a return of capital after a fixed term if the stock market index they are linked to falls. The provider enters into financial arrangements with other counterparties to provide the capital protection.
However, as found when Lehman Brothers collapsed, the counterparty may not be able to uphold their obligations to the product and consequently the return of capital could be affected adversely.
Consideration also should be given to the Financial Services Compensation Scheme limits for deposits and investments. This could affect how much you invest with one institution.
So, I am barely scratching the surface here on this A5 page. A lot of thought needs to be given to how you invest and this depends on a number of factors personal to you. I would suggest that when in the position of considering investments, speak with someone who has access to the whole of the market and can therefore offer independent, impartial advice.
High Edge Financial Planning is an appointed representative of Unleash Advice Partnership Ltd which is authorised and regulated by the Financial Services Authority. Information presented here is generic, does not constitute specific financial advice and are personal opinions of the author. For advice tailored to match your personal circumstances, please feel free to contact us on 07773 426498.
Independent Financial Advisor