When you invest in shares, your objective is for the value of your investment to increase.
However, the value of equities can go down as well as up. So, by investing in shares you are accepting the risk that you may lose money. You could choose not to invest in shares and keep all of your cash on deposit in a bank account. There may be less risk of your investment losing value, because you do not own any shares, but any increases in the value of your investment are likely to be modest, and you could also ‘lose’ money through inflation.
There is a direct relationship between risk and reward. Accept no risk and returns will almost certainly be low. Take greater risks, and the returns have more chance of being higher. The level of risk you take depends entirely on your appetite for risk. That in turn generally depends on personal factors, such as your investment objectives, how long you’re prepared to wait for your investment to grow, and how much of your investment you are prepared to lose.
Understanding different types of risk
In addition to your personal appetite to risk, your investments and returns are also subject to different types of risk. For example, the values of shares listed on a financial market, such as the London Stock Exchange (LSE), tend to move in the same direction in response to factors that impact on the economy as a whole. This is known as ‘market risk’. There are many other types of risk that will impact on your investment. These include:
Your approach to how you manage risk will vary. Placing all your investment funds into one company that has a track record of being highly volatile is a high risk strategy. The value of your investment could increase significantly. But it could drop significantly, too.
A managed approach to risk might be to diversify your investment across several companies’ shares; so if one company performs poorly and another well, you have not lost all of your investment. This type of asset allocation enables you to manage the unique risks of investing in specific companies’ shares.
You can further dilute specific risks by choosing to invest across different asset classes. This might include investing in other types of financial assets, such as a fund, which is when many investors pool their investment into a portfolio of shares, or other financial products. You may wish to invest in other asset classes, such as property, fine art or precious metals.
When investing, consider creating a balanced portfolio of savings and investments. Having established your personal appetite to risk and how much you are prepared to lose, you can research companies and decide what shares to buy.
Remember that all investments – even the ‘safest’ ones – involve a degree of risk. So choose a range of investments that best suit you.