Investing is all about combining your comfort with risk against your expectation of returns to generate wealth.
Risk and return are personal to each investor.
Some investors are willing to take higher risks to increase their returns, while others are more conservative and accept a lesser amount.
Defining your attitude to risk is hard – and to be fair there are a lot of similarities with backing horses and other forms of gambling.
Putting your money on a favourite pays less if the horse wins, and backing an outsider can offer a much improved return.
So what should a savvy investor have in mind when looking at funds or shares?
Importance of diversification
Top of the list is how much you could potentially lose in a year – and could you afford to stand that loss and pay your day-to-day bills
Then consider diversification, that’s the jargon for the mix of cash and assets you should have in a portfolio for your accepted level of risk
Why you are investing is another important factor that determines your acceptance of risk.
If you are investing for income, then you should have a low risk portfolio to reflect this as you cannot afford to lose the money if you are living off your investments.
If you are investing to increase your wealth, then you can afford to take a higher level of risk.
Your age is likely to influence your feelings about risk as well. If you are retired and investing for income, you want to keep your wealth intact, but if you are younger, you have more time to make up for any dips or troughs in the market.
The next question is what is an acceptable level of risk?
How much growth?
Financial experts would suggest that any investor should build a 5% loss into their strategy, while a high risk portfolio could expose at least 40% of your savings.
Don’t forget to factor in tax.
Pensions, ISAs and the Seed Enterprise Investment Scheme (SEIS) all protect capital growth and offer tax breaks for saving, but they can all come with fund charges and different levels of risk as well.
What level of growth should you expect?
This is matched against your risk. Most pensions aim for 5% growth a year, but many funds can achieve much more.
In the end, the greater the risk the greater the return, but as an investor you have to sit comfortable with the risk you are taking on and never gamble what you cannot afford to lose.
