Balancing investment risk and reward is essential when implementing an effective investment strategy in your money mother dough (your family's life savings) to meet your future expenditure needs when you stop work.
Too much investment risk, you could lose money at the wrong time. Not enough investment risk, and inflation could erode your savings pot.
I introduce an acronym to think about when assessing your own risk profile and balancing risk and reward when investing.
KENCAT - Understanding your investment risk profile
Your investment 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 will likely 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.
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