Assessing your risk profile
When making investments, it is important that you have a clear idea of how much risk you are prepared to take in return for potentially bigger returns. Here, we list a few essential points you need to consider.
Are you willing to take greater risks with your investments in order to give yourself the possibility of higher returns? Or is your priority to reduce the likelihood that you will get back less than you invested? Whenever you make any kind of investment decision, it is important that you have a clear understanding of the amount of risk you are willing and able to take before you start out.
The first step when considering your attitude to risk is to make sure you are aware of the different types of risk and how they can affect you. Risk comes in a number of different forms.
The most obvious is capital risk – the value of your investment may fall as well as rise. The capital risk of your portfolio is mostly determined by your asset allocation, which means the mix of bonds, equities and other asset classes that you hold. But there are other types to consider, including:
- shortfall risk – that the return on your investment may not be high enough to meet the purpose for which you were investing;
- income risk – similar to shortfall risk, this means the possibility that you may not get your desired income from your investments;
- inflation risk – that the value of your investment may not keep up with the cost of living;
- interest rate risk – that movement in the base interest rate of a country’s central bank may affect the income from or value of certain types of investment; and
- currency risk – that if you need to spend money in one currency and your investments are held in another, a move in exchange rates may leave you with less than expected.
When you think about how each of these different types of risk may affect your investments, you need to take into account two different factors. One is your risk tolerance and the other is your risk capacity. Let’s look at both of these in more detail.
A question of attitude
Your risk tolerance is about your mental attitude to taking risk – in other words, it’s part of your personality. It measures how much risk you’re willing to take to meet your long-term objectives. Most people find their risk tolerance doesn’t change much over time.
For some people, safety is their number-one priority: they pass up the opportunity for greater returns in return for peace of mind. Others are willing to take higher risks for the potential of higher returns.
It is important to distinguish between risk tolerance and composure. Both of these form part of our attitude to risk, but they are subtly different. Your risk tolerance reflects your taste for risk over the long term – your willingness to put your future wealth at risk for the chance to grow it more. Risk tolerance is about the destination, not the journey.
On the other hand, composure measures how you react to what happens along the way. It reflects your emotional ability to stay the course and stick to your long-term investment strategy when you experience short-term market turbulence.
To find out more about your own risk tolerance and composure, you may wish to consult the latest research from our Behavioural Finance team, which is dedicated to improving the way that people make investing decisions. You can read about their latest findings, and take a free personality test that will give you a basic idea of your own investing tendencies, on their website
Your capacity for risk
Your risk capacity is about your ability to take risks. This will vary according to your personal circumstances. Unlike your risk tolerance, this is highly likely to change over the course of your life.
Risk capacity will be influenced by factors such as your age, your wealth, your debts, and the objectives you are saving and investing for. Two examples of situations that you need to take into account when assessing this are:
- Your goals. If you have a specific purpose in mind, such as paying for school fees or a forthcoming wedding, you will want to be reasonably certain that the money will be available when you need it. This reduces your capacity for risk. If, however, you are simply building your investment portfolio, you may be prepared to take on a bit more risk.
- Your stage in life. If, for example, you are in your 20s and saving for your retirement, you may be prepared to accept a higher degree of risk in the expectation that short-term fluctuations in value will be ironed out over the long-term. If, however, you are already close to retirement and so are likely to need the funds within the next few years, you will probably want to consider less volatile products.
Risk tolerance and risk capacity combined together make up your risk profile. It is this that should determine the long-term trade-off between risk and return in your portfolio.
For example, if you are uncomfortable with the possibility of losing money and need to ensure that your cash is available to pay for short-term goals, your risk tolerance and risk capacity will both be low. You will probably only want to consider relatively safe investments.
On the other hand, if you are willing to take high risks in pursuit of higher returns, have the composure to ignore short-term market volatility, and are mostly investing for long-term goals, your risk tolerance and risk capacity will both be relatively high. In this situation, it may be appropriate for you to consider allocating some of your portfolio to more speculative investments.
Remember, though, that investments can fall in value as well as rise and you might get back less than you invested. If you are unsure, you should seek independent advice.
What to do next and how Barclays can help
Before you begin investing, it is important to make sure you have enough cash savings to cover any expenses you expect to make in the short term. This means considering any major bills you expect to receive within the next five years. It also means setting aside enough money to cover at least three months of regular outgoings, so that you will be able to cope with emergencies such as illness or redundancy. For both these reasons, you will need a cash savings account
Barclays also offers a range of investment products designed to match different risk profiles. For example, our structured products are linked to the performance of an underlying market such as UK or US shares, and are guaranteed to repay all of your capital at the end of a fixed term, though you may get less return than you would have done in an ordinary savings account or even no return at all. Alternatively, we offer managed funds run by professional investors, which give you access to particular markets. The value of these funds can fall as well as rise, and you may get back less than you invested, but they do give you the possibility of earning higher returns.
If you have a Relationship Manager1 with Barclays International Banking, they can introduce you to one of our Investment Advisers, who will tailor an investment strategy to your needs, goals and attitude to risk. To arrange to speak to your Relationship Manager, please call us on +44(0)20 7574 3212*. Please note: we cannot offer investment advice to you in the United Kingdom.
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