BALANCING INVESTMENT RISK AND REWARD

Balancing investment risk and reward is essential to implementing an effective investment strategy in your lifetime’s savings. Get this wrong and you could find yourself short of money to meet your expenditure when you want to stop work.

Defensive assets are cash savings and bonds. They have lower returns but do not fluctuate in value as much as growth assets. Bonds allow you to sleep well. Growth assets fluctuate in value a lot more than defensive assets. Historically, growth assets such as property and equities have exhibited returns well above inflation over the long-term. Equities allow you to eat well.

Holding the correct balance between growth assets and defensive assets is essential to ensure you remain invested during the tough times and are taking enough risk to grow your money mother dough to meet your future expenditure needs.

KENCAT

Your risk profile is made up of 6 factors, we call KENCAT (it’s an acronym). Knowledge, Experience, Need, Capacity, Attitude, Timeframe.

 

Factor Tend to be lower risk Tend to be higher risk
Knowledge Low High
Experience Low High
Need Low – accumulated assets projected to meet expenditure easily High – accumulated assets not projected to meet future expenditure
Capacity Low – income just meets expenditure now and in future High – income comfortably meets expenditure now and in future
Attitude Low tolerance for risk High tolerance for risk
Timeframe Shorter (<10 years) Longer (10 years +)

 

After assessing these factors, you should be able to look at how much investment risk you can take with your investment strategy. Your risk profile will determine the proportion of assets held as ‘growth’ assets (equities, property etc.) and the proportion of defensive assets (cash, bonds etc.). Investors with a higher graded risk profile are likely to have a higher allocation to growth assets.

The Lifeboat Drill

Equities can fall by 50% or more during an equity market crash. Based on your blend of growth and defensive assets, ask yourself if you would be comfortable staying invested if your growth assets fell by 50%?

If you invest £200,000 into a 100% growth strategy, how would you feel if it became £100,000 overnight? If you had a 40% allocation to defensive assets, the £200,000 could still fall to £140,000 or lower based on our example.

Remember, historically all investment market falls have been temporary and equity markets have fully recovered over time.

Next steps

Establish your risk profile and ensure your investments (that includes your pensions!) are balancing risk and reward to meet your future goals.

Your capital is at risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.