Portfolio Risk Strategy

Your approach

What plans do you have for the future? What point are you at in your life? Do you have specific goals, such as funding retirement or a major purchase?

The first step when investing is to clarify your priorities. That’s because a good investment isn’t necessarily the one that performs the best in any one year – it’s the one that’s most appropriate to your circumstances and outlook.

It’s important to consider the level of risk you’re willing to accept. Investments that carry a high level of risk, such as equities, tend to perform better over the long term than less risky investments, such as bonds. But, in the short term, they can be subject to wide swings in value.

Another important consideration is whether you need your investment to produce an income. In that case, low-risk, income-yielding investments may be more appropriate. The trade-off is that they often deliver returns only at, or slightly above, the inflation rate. So there’s the possibility that the value of your wealth will be eroded over time.

Once you’re clear about your priorities, you can begin to decide what investment is right for you. We categorise investors in terms of three different levels of risk.

Be Level-headed About Risk

Low Risk

As a low-risk investor, you want better returns than those offered by a bank or building society savings account. Accordingly, you are prepared to put a limited part of your money in stock-market investments. While you are willing to accept some level of risk – which means your investments may fall in value – you want to restrict that risk. That means you are only willing to put money into investments that are unlikely to fall substantially in value by the end of your intended investment period. Hence, you will probably have limited exposure to equities, with a large proportion of your portfolio invested in lower-risk assets, such as bonds and cash.

You accept that this cautious approach may limit the potential for your money to grow, and there is the possibility that it may not maintain its spending power over the medium to long term. That’s because low-risk investments often deliver returns only slightly above – and sometimes even below – the inflation rate, exposing you to the possible erosion of the value of your wealth over time.

Medium risk

As a medium-risk investor, you want the spending power of your investments to increase or your income to maintain its spending power over time. You are happy to consider putting a higher percentage of your money into stock-market investments than the low-risk investor, with the aim of getting a better return – hence, you are likely to have a greater exposure to equities. But your portfolio will probably still have a large component of lower-risk assets, such as bonds.

You accept that the money you invest will not be completely safe and that you could make a loss – especially if you need to withdraw your money within five years. In the short term, riskier investments (such as equities) tend to be more volatile – in other words, they can be subject to wide swings in value. Yet they also have the potential to perform better over the long term.

High risk

As a high-risk investor, you want to achieve higher total returns, by putting a greater part of your money in stock-market investments. Hence, your portfolio is likely to be dominated by equities, with perhaps a small component of bonds and, to a lesser extent, cash.

You are aware that, if you invest in this way, your money could be subject to far greater fluctuations than that of the medium-risk investor and that the potential for loss is greater. That volatility means there is no guarantee of a positive return in any single year – hence, such a strategy is likely to be unsuitable for investors who require a consistent income. Yet higher-risk investments tend to grow faster than more stable investments. So, over the long term, you increase your chances of achieving the higher total returns you seek.

Capital Partners London Ltd -  1999-2007