How to Choose an Investment Risk Level That Suits You

Managing risk is an important part of investing and can play a key role in ensuring that your portfolio is working to match your expectations. The best strategies look to maintain a level of comfort when it comes to managing your investments while also delivering the kind of results that you want. 

In the United Kingdom, risk has typically been a major driving force when it comes to managing investments. Factors such as recent market crashes, the property boom, and rising taxes have created a national aversion to high-risk investments. As a result, the average investor's portfolio is twice as likely to hold cash savings as investments like stocks and shares. 

According to a survey carried out last year, 60% of UK savers avoid investing because they feel that it’s too risky. Worryingly, the results also showed a fundamental misunderstanding of how wealth management works, with 51% of respondents unaware that cash savings can lose value over time because of inflation. 

But there are many different ways to save, and different equities can deliver a wide range of results based on how risky they’re perceived to be. So how can you begin your investment journey at a risk level that matches your comfort levels and wealth management ambitions? Let’s take a look at the key considerations to take when making investment decisions: 

Knowing Your Risk Tolerance

Risk tolerance is an important part of investing. After all, if you aren’t confident in your portfolio’s ability to withstand market shocks, you’re not going to have a comfortable time managing your equities. 

The important thing to keep in mind here is that risk is psychological. If you’re prone to selling up faster when you’re panicking about devaluing stocks and shares, you’re in danger of locking in your losses. 

However, when we look at the historical performance of investing compared to saving, it’s clear that investors can expect more growth than savers. 

According to Unbiased data, the average return on a Stocks and Shares ISA over the past 10 years is 9.64% annually. Compared to the 1.21% average for cash ISAs, it’s clear that while investing can be riskier, the rewards are often far greater. 

The great thing about modern investment platforms is that they will often assess your risk tolerance to better understand the type of investments you want to make. For instance, consider Wealthify and its range of five ‘investment styles,’ which cover approaches like ‘cautious,’ ‘tentative,’ ‘confident,’ ‘ambitious,’ and ‘adventurous.’ This can help to simplify risk management in a way that newcomers can understand for a better investment journey. 

Many good investment account providers will offer simple assessments and quizzes that will seek to understand your emotional baseline. Once they have insights into your risk tolerance, they can get to work on creating a strong portfolio that matches your comfort levels. 

Keep Your Financial Goals in Mind

The problem with risky assets is that they’re usually more speculative and thus have a better capacity for growth over time. This means that you should properly consult your financial goals to ensure that they’re compatible with your risk tolerance. 

For instance, if you’re looking to save over a shorter period of less than five years, risky assets may be more prone to creating losses because any market shocks could see your portfolio lose money, with there not being enough time to recover your funds.

However, longer-term investing can really help more speculative stocks to outperform the wider market and quickly absorb short-term losses, provided that they have the right fundamentals and strong expectations for future revenue growth. 

When it comes to pension investments, most people approaching retirement age will cycle away from risky investments to ensure that their pot isn’t impacted by short-term market fluctuations before they take their money out. 

Understand Your Capacity for Loss

You should also understand how much loss you’ll be comfortable with when assessing the investment risk level that’s right for you. 

For instance, if your portfolio were to fall 20% or 30% overnight, would it cause you financial discomfort when paying your everyday expenses? 

You may find you have a low capacity for loss if you’re close to retirement or will rely on taking money out of your investment portfolio in the short-term to make ends meet. However, if you already have a steady income, access to emergency funds, and are many years away from retiring, you’re likely to have the capacity to absorb short-term losses without having to realise them. 

Investing on Your Terms

While many adults in the UK are wary of investment risk, buying and holding equities has historically proven to be more effective than cash savings. It’s the risky nature of investing that makes it more effective over time than saving, and more speculative assets can help to push portfolios higher, just so long as they have the fundamentals to back them up. 

But investing is only effective when you’re comfortable with your portfolio. If you’re wary of your more speculative investments, you’re more likely to panic sell them after market downturns, which can lead to heavy losses that can’t be recovered. 

With this in mind, take a moment to look at your capacity to handle loss, assess your financial goals, and use providers to better understand your risk tolerance to help you build your investments with peace of mind.