We often forget that the world is full of different types of risk - think about the risk of losing your job 💼, or the risk that you experience side effects from some medication 💉, or (this one is morbid) the risk of dying while crossing the road ☠️.
From an investment perspective, we can think of risk as the chance that an investment’s actual returns will be different to what we expected when deciding to make the investment. This is driven by uncertainty around how the future will develop.
Why does this matter?
Investment risk includes the possibility of losing money. Obviously that’s not what we set out to achieve when investing, but it’s a possibility which is very important to be conscious of - even Warren Buffett sometimes loses money!
The key here is consciousness - being aware of the specific risks you are taking will help you become a more confident and hopefully successful investor over time!
Why would anyone want to risk losing money?
Investing involves putting your money to work to earn you a return over time, with the goal of helping to achieve your future financial objectives. But to earn that return and grow your wealth by investing usually means taking various kinds of risk.
Broadly speaking, making riskier investments usually has the potential to earn bigger returns, but also the potential to lose just as much! This is why, for example, investing in government bonds (usually considered a “safe” investment) is unlikely to grow your money by as much as investing in stocks (the riskier stuff).
Being aware of the various risks you are taking when investing will help you take the right amount of risk for you in order to grow your portfolio over time.
Two ways to think about your personal risk profile
A good starting point is to figure out your ability and willingness to take risk.
Ability relates to external factors such as:
Income: Do you have a stable income? Are you able to cover your cost of living? Are you able to save a little bit each month? If the answers are “Yes” - lucky you - you are able to take risk!
Age: If you are young, you likely have a higher ability to take risk, given you have a whole lifetime ahead to recover any losses you might make.
Dependants: If you have others who depend on your income, you may have a lower ability to take risk
Financial objectives: Are you saving towards a mortgage, car, holiday, or are you investing for your pension?
Willingness relates to internal factors:
Personality: When it comes to your money, are you comfortable taking some risk in order to grow your wealth? Or does the thought of risking some of your money make you feel dizzy? It sounds pretty obvious, but the more comfortable you are with the idea of risk, the higher your willingness to take risk.
When it comes to investing, being honest with yourself about your ability and willingness to take risk is a great place to start - the key is to figure out the best starting point for you and work from there!
Once you have a good feel for how able and willing you are to take risk, it’s time to learn about the many different types of investing risk! Knowledge is power, after all! ✊
The main types for you as an individual investor to consider include risks which come from the external world around you (Systematic & Specific risks) as well as those which might arise due to a change in your ability or willingness to take risk in the future (Time Horizon risk)
Please know, the value of investments can go up as well as down and you may receive back less than your original investment, meaning, when investing your capital is at risk.
Disclaimer: At Evarvest we believe in making investing and investment education more accessible, but we don’t provide investment advice and individual investors should make their own decisions. While we try our best, we cannot ensure the accuracy of the information we provide.
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