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For readers in a rush:

Investment risk sounds scary, doesn’t it? Anything with the word risk in it is, let’s face it, a little off-putting.

Why would you want to do something that involves risk?

But we encounter risk every single day and investment risk is no different. It’s actually a very good thing.

But first, the fine print. This article can give you helpful tips about investment risk. But it isn’t personal advice. It won’t give you specific examples of a risky investment versus a non-risky investment. If you’re not sure if something is right for you, you can find an advisor at Unbiased Link opens in a new window. Investments can go down as well as up and there’s a chance you could get back less than you put in.

What’s risk?

Risk-taking is an important part of being human. It allows us to explore and learn about the world around us. When we’re faced with a risky situation, our brains go through an evaluation process.

In a nano-second it weighs up the potential rewards and risks associated with doing the action in front of us.

In simple terms, risk keeps us safe.

For example, if you’re planning on going on a long car journey, you check your tyre pressures to reduce the risk of getting a flat on the motorway. Or, if you’re coming to a sharp turn, you reduce your speed to reduce your risk.

By taking small steps that have become second nature to us, we increase our safety nets by reducing risk.

The other benefit of risk is that it keeps us in control.

When we’re able to make decisions about the risks we take and the steps to avoid it, we feel more in control of our lives and are less likely to feel helpless in the face of danger.

What’s investment risk?

When you invest, there’s a risk that you could lose money because of fluctuations that cause the value of an investment to fall.

For example, if you buy shares in a company and the value of those shares decrease, you’ve lost some of your investment.

There are loads of different factors that can cause changes in the value of an investment, like changes in the economy (think Covid-19), political events (think change of prime minister) or changes in the market (think the 2008 financial crisis).

Some investment choices can be riskier than others.

Buying shares in individual companies in the UK is generally riskier than buying a fund that invests in companies in different markets across the world, for example.

The former increases your risk by not spreading it out. And the latter spreads your risk out through the diversification of different types of investments and different geographies.

Why is investment risk a good thing?

1. Just like in normal everyday life, investment risk keeps investors safe and in control.

If you’re not okay with taking on lots of risk, that’s great. It means you’ve weighed up the pros and cons. And maybe having more stable growth over a longer period matters more to you.

If you’re okay with taking on more risk, that’s also great. It means you’re more comfortable with potentially losing money, as well as potentially making higher returns. Different types of investments, called assets, also have different risks and rewards attached to them.

For example, stocks are generally riskier than bonds. Stocks are shares in companies, and bonds are like an IOU from companies (or even governments) to investors. UK government bonds are known as Gilts. Bonds and Gilts offer a fixed interest payment, so you always know what you’re getting back.

Stocks are risker but have the potential to give investors higher returns.

Returns are the difference between the amount you originally pay for an investment and the total you get back. Including income received and the final value.

One of the reasons stocks can give investors higher returns is because they pay out a dividend. Dividends are a portion of the company’s profits that the shareholder is entitled to as a joint owner of the company. They’re not fixed like bonds are. So, they have the potential to grow higher than the fixed rate of return that bonds pay out. But if the company makes less profit than expected, dividends may disappear.

The other way investors can see returns when in investing is through capital gains. This is the increase in the value of an investment when it’s sold. But it’s swings and roundabouts. Because stocks also have the potential to go down as well as up.

2. It reminds investors to stay diversified

There can be more risk attached to certain types of investments. Which means investors can actively reduce their risk when it comes to how they invest.

Investors can spread their investments out in a few different ways. Such as

  1. Across different assets (types of investments)
  2. Through different industries
  3. With different markets around the world

When you spread your investment across different countries and industries, you’re creating a diversified portfolio. This helps to reduce the risk of losses on your investments. That way, if one country or industry does well and another doesn’t, you can offset some of your losses with any gains, which reduces your overall risk.

3. Investment risk could help you to achieve your goals

It’s really important to remember that investment risk is different to financial risk. Financial risk is more about the possibility of not being able to pay your bills. It’s important to make sure you’re always able to meet your financial obligations.

If you’re making large investments and you’re not taking risk into consideration, it could affect your financial wellbeing.

But managing investment risk can help you to achieve some of your financial goals (like retirement).

When you’re nearing retirement age, a common strategy is to reduce investment risk. This helps to protect you from losing money close to when you want to be taking money from your pension pot.

When you’re younger, you can afford to spend more time being invested. This can help you to weather any ups and downs in the stock market.

You don’t have to do all the hard work yourself either. You can invest in funds that spread your money out depending on how much risk you want to take on.

A fund which has some higher risk as well as lower risk investments, could potentially earn higher returns than a more cautious fund.

So, in a nutshell, investment risk helps keep us safe and in control. It doesn’t mean investing is super safe, and there’s always a risk of losing money, but by staying diversified and always checking in with your risk appetite, you could be on your way to a happy investment journey.

Where to next?

We hope the information in this article is useful, but it isn't financial, personal or tax advice. If you want expert advice, you should speak to an Independent Financial Advisor. Remember, the value of investments can go up and down, so you may get back less money than you put in.

You should think of investing as a medium to long-term commitment – so be prepared to invest your money for at least five years. Tax depends on your individual circumstances and the regulations may change in the future.

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