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Risk

Risk explained
Investing usually involves some level of risk. But if you understand it, and take steps to avoid unnecessary risks, you can even make risk work in your favour.

Deciding how much risk you're happy to accept is one of the most important parts of investing. After that, you can use this knowledge to pick the range of investments that's right for you and your plans for your money.

Here's our simple guide to the different types of investment risk, to help you understand them and how they may apply to you.

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Investments and risk

In general, higher-risk investments have a higher potential return, and lower-risk investments usually produce a lower return. The more risk you take, the more your investment could grow. But if things go wrong, the more you could stand to lose too.

Cash savings

A savings account is low risk, with up to £85,000 of your savings protected by the Financial Services Compensation Scheme. On the other hand, you won't receive much income if interest rates are low − and the 'real' value of your savings could drop if interest rates fall below inflation.

 

Bonds

Investing in bonds is like giving a fixed-term loan to a company, government or other organisation. You can make an income from the interest on your 'loan', and your capital should be repaid at the end of the fixed term. But there's a risk of default on interest payments, and this risk can vary greatly according to the organisation that's issuing the bonds. And like cash, bonds can fall victim to inflation and unfavourable interest rates.

Read our spin-free guide to bonds >

Equities

When you invest in company shares you become part owner of that company, so the growth of your investment depends entirely on its fortunes. There's no limit to how much your investment could grow, but there's also no limit to how low a share price could fall. This means that if you invest in shares, there's the risk of losing your original investment.

Read our spin-free guide to equities >

Property

The amount of income you can make from property will fluctuate according to the general trends of the property market. Property is considered more stable that shares, but it's still subject to volatility, so your initial investment is not 100% secure.

Read our spin-free guide to property >

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Common types of risk

Different types of risk can affect investments in different ways. Depending on your investments, here's a summary of the risks that you may need to keep an eye on:

Capital risk

Due to market factors beyond anybody's control, you may not get back the original amount of capital which you originally invested.

Credit risk

A company, government or other organisation may fail to make payments on a bond.

Currency risk

If you invest overseas, you may eventually need to convert your money back into sterling, possibly at a less favourable exchange rate.

Inflation risk

Inflation may erode the value of your investment over time.

Interest rate risk

Changes to interest rates may have an impact on your investment.

Liquidity risk

In finance, this is the risk that your assets can't be sold quickly enough to prevent a loss, or make the required level of profit.

Market risk

If the financial markets collapse, maybe because of a major economic shock or institutional failure, your investment is likely to be affected.

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Managing risk

Although the value of investments can be affected by many different risks, there are several strategies you could adopt to manage risk overall:

Diversify

A diversified portfolio, with investments spread across several asset classes, may be more stable overall as the market rises and falls. Combining bonds, equities and property can help to reduce the impact of shocks.

Invest regularly for the long term

By making regular investments for the long term, you may be able to smooth out the highs and lows of price movements. You could also have time to recover from any short-term dips, and potentially benefit from long-term overall growth periods.

Invest in funds

Investing through a managed fund means you won't be investing alone − you'll pool your money with others and spread it across a wider range of investments.

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Deciding how much risk you want to take


It's important for you to work out the level of risk that's right for you and your investments.
One straightforward way to start doing this is by thinking about your long-term plans:

  • How much time do you have to allow your investments to grow?
  • How much money would you like to have at the end of your investment period?

Taking too much risk over a short period of time could produce problems. A high-risk investment may grow your money in the long term because you've got time to recover from short-term dips. But if you cash in your investment too soon, you could lose money.

On the other hand, taking too little risk in the long term may mean you'll end up without enough money for your needs. Placing money on deposit is low risk, so your savings would be safer in the short term. But you may be left with less money over the long term if interest rates don't keep pace with inflation.

By thinking carefully about the questions above, you'll be well on your way to understanding your own personal 'appetite for risk'.

Taking on too much risk, or not managing it properly, could mean that you'll possibly lose some or all of your original investment.
Risk refers to uncertainty, so all investments carry some level of risk.

It's natural for investments to fluctuate. As a result, fund prices will fall as well as rise, and you may not get back the original amount you invested.