Article

How much risk can I afford with my savings?

The amount of risk changes a lot depending on when you need your money back, so it's important to consider all the different possibilities. An investment manager will help you to do this.

| 6 min read

When a saver first encounters an investment manager, they will face a strange technical question. They will be asked: what is their risk appetite? If they are lucky, they will be asked in more standard English if they can say whether they are willing to make investments that could, at least temporarily, go down in value in the hope of making more money over the longer term.

The investment manager needs to explain that people often buy shares in companies or buy into bonds, which are debt instruments issued by governments or businesses to finance themselves. The good news is that these shares and bonds can be sold anytime the markets are open and have easily accessible quotes or prices at which they can be sold. The not-so-good news is that they can go down in value as well as up after you bought them.

The idea is to buy shares that, over time, will go up in value because the companies do well, make more profit and pay more income to shareholders as dividends. That should mean you do better than keeping the money on deposit at a fixed rate of interest.

Attitude to risk is central to the plan

In those early conversations, the investment experts explain enough so the potential client can start to answer questions about how much risk they can afford to run and are willing to accept, without leading the client. The client needs to consider whether they might need the money in a hurry. If so, risky investments are a bad idea as, when they need to sell, prices might be down. They need to work out if the money is going to be required to pay their living costs. If so, it would be wise not to take too much risk.

Some may have saved sufficiently for their current needs. If a potential client owns their own home and has a steady income or pension to pay the bills, the extra financial savings could be put to work in riskier assets. It still does not mean people will necessarily be happy with this. Some take the view that they have worked very hard to earn their surplus – and they do not want to lose some of it by investing at the wrong time or in the wrong assets. Others may see the way in which longer-term investors usually over most time periods earn superior returns for taking sensibly managed extra risks and be happy to try that themselves.

These conversations result in the client agreeing on a risk level at which their money will be managed. If the client wants to avoid possible significant losses in a market sell-off, they will choose a low-risk option. The portfolio will then avoid most higher-risk shares and bonds, concentrating more on bonds with relatively stable prices and offering a bit more income than a deposit. If the person opts for the maximum possible growth, they choose a portfolio largely in shares to gain plenty of exposure to what growth is available. The manager has numerous controls to ensure the portfolio is going to offer the choice of the client.

Attitudes are not static

A big issue is that an individual’s risk appetite can vary over time and as market moods change. A client might sign up to a higher-risk portfolio during a bull phase in stock markets when the general mood is one of confidence against a background or rising share prices. A year later there might be a recession threatening. The person's own business may be struggling – or they may worry about their job. They may have a job or a business that is well based but watching the news may have persuaded them that now is not such a good time to have savings at risk. This means the client and investment manager need to be in touch, and there is usually a regular review of the client's attitudes to risk.

There are various technical definitions of risk. Most of them relate to price volatility.

Changing your mind about risk too often as economic and market moods changes can be destructive to a good investment approach. If your money genuinely is long-term money that you do not need any time soon and your aim is to increase it faster than by keeping it in a bank account, then it is usually wrong to uproot it when the market goes through a setback for some months. It requires you to snap back your love of risk in good time – before or as the market bottoms out – otherwise you will miss some of the best days of rises as the market turns round. You are often best advised to leave some discretion on this to the investment adviser and to stick with your underlying attitude to risk.

There are various technical definitions of risk. Most relate to pricing volatility, how quickly given shares or markets can go up and down again. Managers have access to plenty of price data so they can see how volatile a given share or index has been and can decide if the risks of price change are worth running given the expectations of longer-term investment returns.

Clearly, an asset which has been very volatile but has not delivered good longer-term returns has not been a good idea, though it could become so if there are good reasons why it has been depressed and may at last start to perform.

Whilst there are many sophisticated risk measurement tools, and many methods of controlling risk, in the end, it comes down to a matter of judgement. They are your savings – and you need to be happy with how they are managed. Nevertheless, it is usually true that if you can accept more risk, you should be able to earn a better return.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

How much risk can I afford with my savings?

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