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Howard Goodship, IFA Ringwood - What is the “right” level of risk?
Monday 10 January, 2022
The definition of risk in the dictionary is “expose (someone or something valued) to danger, harm or loss”.
Regarding investments it relates to the exposure to loss, which it is fair to say no-one enjoys! However, experienced investors understand that in order to achieve better long-term returns (minimum 5 years and ideally 10 years plus), they are required to take a certain degree of risk.
Here are some facts, sourced by JP Morgan from Morningstar & HM Land Registry, to support this:
£50,000 in 1987 would now need to be worth £147,000 to have kept up with inflation (UK RPI). Assuming that was left on cash deposit, it would have been worth £109,516 which is a real term “loss”. This defeats the argument that cash is a no-risk investment as it virtually guarantees a loss of purchasing power, especially over the long term.
£50,000 invested in UK House prices in 1987 would be worth £348,425. There have been periods of “loss” during this time but there have been significantly more good years than bad years.
£50,000 invested in the FTSE All Share Index would be worth £705,110 (dividends re-invested). During this time there have been 11 negative years and 22 positive years for the FTSE All-Share. If we consider investment markets more widely the Standard & Poor’s 500 index in the US has suffered 6 negative years during the last 33 so has been positive in 82% of the years. The good years have definitely outweighed the bad (although this cannot be guaranteed).
What other things should be considered when deciding on the right level of risk?
We consider a number, each contributing to our final recommendations for clients.
- Your intuitive attitude to risk. How comfortable would you be in a year when your investments drop in value and would you remain invested or panic and sell (thus crystalising a loss).
- Your experience of investing. The more experienced, the more likely you will understand that negative years are simply part of investing, having experienced market falls and subsequent recoveries in the past.
- Your capacity for loss. We can measure (through our cash-flow tools) the actual % loss a client could suffer and still meet their stated objectives. The higher the figure, the more confident a client can be that they will meet their objectives and that they can “afford” to take a certain level of risk.
- The timescale before you require the invested capital. This is likely to result in a mix of risk levels being held; short-term cash, medium term investments balanced to your attitude to risk and if money is identified as not being required for 10/15 years plus then potentially a further step-up in risk for potentially greater long-term returns (but more short-term volatility).
- We also test a client’s stated intuitive attitude to risk. This is via a series of questions, the answers to which are run through an external psychometric testing tool, to identify whether a client’s intuitive responses are aligned with likely future behaviour.
Howard Goodship, Chartered Financial Planner and member of our Ringwood financial planning team said:
'To summarise, taking no risk by leaving all funds in cash is actually a sure-fire way for a reduction in your saving’s purchasing power over time. Investing is a solution to that issue, albeit it comes with other risks. The degree of risk (and volatility) can be selected and controlled but cannot be eliminated. The key to a successful retirement in financial terms can be to own a balance of cash and risk-controlled investments. The optimal balance will depend on your personal lifestyle, sensitivity to fluctuations in the value of your capital and your timescale. If you’d like to learn more or discuss your personal situation, we would be delighted to meet for a free, no obligation initial chat.'
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