What Is Investment Risk?

Last week we brought you a guide to investing which looked at the different types of investments, from shares to bonds to property and cash.

We’re now back with another article from Nutmeg, this time discussing investment risk.

We’ll also be looking into the different ways you can begin to invest your money, covering DIY investing, to joining Nutmeg through the Emma app.

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How much risk should I take?

In investment, as in life, it is easy to encounter risky situations where you can lose out. Here we go through the nature of risk and how you can minimise it when it comes to investing.

Investing can be seen as a form of risk management, seeking the returns you want against the risk you are willing to take. 

1. What is investment risk and why do some find it attractive?

Risk is not the most inviting of propositions but when looking at risk in terms of investing, fear needn’t be a factor. Truly understanding risk as a concept is simply a cornerstone of successful long-term investment management.

Risk describes the uncertainty of the returns on an investment. It is an indicator of the potential for losing money and making money. Although we often do not think of it this way, it can mean returns could be unexpectedly high – although with a higher chance that you could lose more too.

Different investments will be more or less risky. Shares are considered riskier than bonds, although this is not true for individual shares and bonds. Investments that are more likely to give higher returns in the long run may have a bumpier ride along the way, whereas investments with a lower return potential are often more likely to remain steady and stable for the duration.

Put simply, investments that have higher risk usually have higher rates of return. So, individuals who are looking to increase the value of their investments significantly, and who are prepared to accept that the value of their investments might fall, are more likely to choose to invest in assets that have higher risk. 

No single asset class can be relied upon to produce safe, reliable and consistent returns. However, some investments come with significantly more risk than others. For example, cryptocurrencies, such as bitcoin, are viewed by many commentators as a speculative investment, only suitable for those willing to take a considerable amount of risk and willing to withstand heavy losses. 

At Nutmeg, we believe that a diversified investment portfolio — with an appropriate proportion of cash, equities, bonds and commodities for your goals and risk tolerance — is a better way to maintain and build wealth over the long term.

2. Only risk what you can lose: how much risk can you afford?

Nobody really likes risk, but some are more able to tolerate it.

Knowing how you feel about risk is the first step in determining what sort of portfolio of investments is right for you. This is important as you need to know that you can stay the course if your investment falls in value, as it almost certainly will from time to time. Also, if your portfolio is too cautious, you may be disappointed by the returns you get.

At Nutmeg, we help people find their risk tolerance with a well-established and rigorously tested risk assessment. By answering ten questions, you can establish your attitude to risk which will help you understand how you feel about investment risk and determine what the right investment strategy is for you.

A good question to ask yourself is: ‘What would it mean for you if your investment fell in value?’. The above table gives some idea of what has happened in the past. Give some thought to how it would affect your plans and your standard of living.

If you have flexibility about when you need your money, you can leave the money to recover from a downturn. How long that takes has varied widely from a few months to a few years and will also depend on how it is invested. This is a very good way of managing risk, but requires the financial and psychological ability to delay cashing out your investment.

At Nutmeg, we show you what the downside may look like so that you can really think about what that would mean for you.

3. Nothing is risk free

Even leaving money in the bank involves some risk, that of inflation.

Sometimes people have a general idea of what they want from their investments, for example to keep up with inflation or to preserve their capital, but in trying to do any one of these you are likely to have to accept some level of risk. The beauty of investing carefully, across a range of assets is that your risk can be diversified and typically if one asset goes down, another will go up as the market moves to compensate. That’s why bonds can become more valuable as equities fall – there is more demand for assets seen as less risky – so it really is a good idea to hold both. 

When you understand risk and know how much risk you want to invest in, it’s easier to see good investment as a great way to offset the general risks that are inherent in holding money and assets.   

Being risk aware is crucial to good investing

People may also have a more specific goal, such as to build a pot of £10,000 in 10 years’ time to fund a dream holiday. Gauging risk will help you know whether that is realistic given the risk strategy, contributions and timeframe. We help you understand this with our projections which you can access any time by editing the risk level on one of your Nutmeg pots.

If you are going to fall short, rather than change the amount of risk, we will suggest changing your contributions or extending the timeframe. You can also reduce the amount you are aiming for. Alternatively, if you are going to overshoot your objective you can reduce your contributions, dial down the risk or bring forward the timeframe.

How do I invest?

So, if you’ve decided investing is right for you, how do you go about starting your investment journey? Traditionally there have been two options: do it yourself or pay someone to do it for you. 

1. DIY investing

You can decide for yourself what sort of portfolio you want, then choose and buy funds using a platform. There may be both platform fees and fund fees to pay, there may also be transaction costs and additional charges for an ISA or pension.

You will need to keep an eye on your funds to check that they are doing well and that the balance of asset types remains right for you. This approach may be more suitable for more confident and experienced investors or those with a lot of time to oversee their investments.

Some platforms offer ready-made portfolios. You select the risk level and they will choose the funds. These may have an extra layer of fees as a management charge. You pay for their professional oversight of the portfolio.

Some investment companies allow you to buy their funds directly, although you will still need to choose the funds yourself. The advantage of this approach is that you do not have to pay a platform fee. The disadvantage is that you will have to monitor each fund separately, and you’ll receive paperwork for each fund. As with a platform you will need to keep an eye on your funds to check that they are doing well and that the balance of asset types remains right for you.

2. Get some help

A financial adviser will recommend a fund or set of funds for you, based on your circumstances, but costs and service levels can vary hugely. They should spend some time with you, discussing and agreeing the right risk strategy for your portfolio. You will perhaps pay on an hourly basis for their time and there may be an initial charge for setting up the funds and an ongoing charge as a percentage of your investment as well. Usually, this works best where you have a large amount of money to invest.

The traditional way to build a portfolio was through a stockbroker. This works best when you have sufficient money to buy a selection of shares and bonds. The stockbroker will recommend good buys and, with your agreement, will place the trades for you. There will be a small tax to pay on each share purchase and your stockbroker will charge you a commission as well, with varying charges per transaction.

Another more traditional long-term investment management approach is through a portfolio manager, who makes decisions on your behalf. Known as ‘discretionary management’, the practice involves the manager making investment decisions at their own discretion without asking you. The decision-making process requires a lot of experience in the industry alongside relevant qualifications. As a result, it can be expensive and often only available to very wealthy clients.

3. Nutmeg

Nutmeg is an online discretionary wealth manager. You will need to sign up and answer a few questions to enable us to suggest an investment portfolio for you.

The specific investment will depend on the amount of investment risk that you are willing to take and the investment style you choose.

You will pay us a percentage, from 0.25% to 0.75%, (incl. VAT where applicable) of your investments, and depending on the amount invested. Additionally, you will incur the underlying fund costs and the effect of market spread. For further information about the cost of investing, see our costs and charges.

Nutmeg aims to give clients the best levels of discretionary investment. Without the high costs that bar most people from entry. Our award-winning service provides globally diversified investment portfolios for everyone, whether you have £100 (£500 for an ISA or pension) or £1 million.

Three investment styles. One great service.

We offer three investment styles for you to choose from for your investment pot with Nutmeg, and all of our portfolios are diversified across asset classes, countries and sectors.

Fixed allocation

Offers a diversified and regularly rebalanced portfolio, with a range of risk levels available.

Learn more 

Fully managed

Offers a diversified and regularly rebalanced portfolio, with a wide range of risk levels available. These funds are proactively managed by experts. 

Learn more 

Socially responsible

Offers a diversified and regularly rebalanced portfolio, with a wide range of risk levels available. These funds are proactively managed by experts and have an SRI focus. 

Learn more 

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Tax treatments apply. Learn what we mean by risk