Risk & Reward Ratio
”When saving or investing money, two of the most important factors are risk and return.”
Financial Advisers will ask a client that wants to invest to complete an Attitude to Risk questionnaire and the answers from this will result in a risk score. This score is then used by the adviser; a risk/reward ratio is used to compare the expected returns of an investment with the amount of risk taken to capture returns, to design an investment portfolio that will match the clients desired risk score.
The risk level on any type of investment is a way of describing how likely it is to lose money. Bank deposit accounts for example are a safe investment and therefore have very low risk. The only way to lose money is if the bank became insolvent and there was more than the government compensation guarantee level of £ 75,000 held with it. Of course you also have to remember that if the interest rate is lower than inflation then the value of the deposit is actually worth less.
On the other hand, for example, buying shares in a new technology company, would be considered as very high risk. In the event of that company’s products or services not succeeding it would lead to losses for the investor.
However, the potential returns for both of these examples are very different. Interest rates are so low you wouldn’t expect to see much more than a few percent growth each year while your money sits in a deposit account. Whereas, being in a digital generation, many tech firms are becoming very successful, especially if they are bought out by the larger companies and therefore have the potential to see rapid growth. The lower the risk the lower the potential gains and likewise the higher the risk the higher the potential gains.
As you approach retirement investors traditionally switch savings out of risky investments and into safer assets. If the markets take a hit and affect savings while you’re young there is still have plenty of time for them to recover. The same cannot be said if this happens when you are expecting to start cashing in on those savings soon.
Historically once you reach retirement, the goal for most is no longer to grow the nest egg as much as possible. But to ensure that the accumulated savings will provide with an income throughout retirement.
However, for many people retirement could be 20+ years and therefore they will still hope their savings and investments are able to receive a decent amount of growth. The best approach is not to remove all risk. Make sure that you have a portfolio that has a good spread of investment sectors and geographical locations that are within your personal risk limits. The easiest way of doing this is to talk to an independent financial adviser that specialises in investment management.
If you have any questions on investment risk, contact us here.