Do you like to take chances, or are you conservative by nature? You may think you have a high tolerance for risk but it can boil down to one simple consideration - how would you feel if you lost some of the money you had invested?
It’s important to do some soul searching here because your attitude to risk can – and should – influence your choice of investments.
That’s because risk generally goes hand-in-hand with potential investment returns. Every investment involves some degree of risk, and it can be near-zero for cash deposits or it can be very high in the case of more exotic investments like art. Shares and property generally fall somewhere in between.
One of the foundations of investing is that risk equals return. So a simple way to gauge the sort of risk involved with an investment is by looking at the likely returns. And if you come across an investment promising a high return, chances are it involves a high degree of risk that you could lose some or all of your money.
As an investor, risk is not something you can avoid altogether. All investments have some risk and you need to be aware of the nature of that risk. The key is to consider how much risk you are comfortable with, and to invest accordingly.
An investor with longer term goals may be prepared to invest in higher risk growth assets like international shares. Achieving goals over the longer term means there is more time to recover from potential losses along the way.
Investors with shorter term goals, who are likely to include older investors relying on their investment returns as a source of income, may be less willing to invest in higher risk assets. Nonetheless, with life expectancies rising, it may still pay for these older investors to hold at least part of their portfolio in growth assets like shares. This can help to avoid a situation where they are forced to draw down on their capital quicker than expected because their income is insufficient to to meet their immediate needs - that is, their money runs out before they do.