What is Investment Risk?
​Investing always involves uncertainty, and for many, the word "risk" can trigger thoughts of losing everything. However, investment risk is much more nuanced than simply losing all your money.
Understanding the types of risks you may encounter and how to manage them is key to making informed decisions and being able to move forwards with confidence.
We believe that with the right knowledge and strategies, you can approach risk in a way that aligns with your financial goals and comfort level.​​
Types of Investment Risk and How to Reduce Them​​​
1. Market Risk (Systematic Risk)
This is the risk that the entire market will decline, affecting the value of your investments. No matter how diversified your portfolio, you cannot avoid market risk entirely. However, you can reduce its impact by holding a range of assets across different markets and sectors. Additionally, holding investments over the long term tends to smooth out short-term volatility, allowing you to benefit from overall growth trends.
2. Credit Risk
Credit risk refers to the possibility that a bond issuer or borrower may default on their debt payments. You can manage this risk by choosing high-quality, creditworthy bonds or diversifying your bond holdings across different issuers and regions. Alternatively, government bonds are typically lower risk than corporate bonds, though they may offer lower returns.
3. Liquidity Risk
This is the risk that you won’t be able to sell an investment quickly enough to avoid a loss or take advantage of a new opportunity. Liquidity risk is often found in assets like real estate or specialised investments. To mitigate this, ensure your portfolio includes liquid investments like shares or funds that can be quickly sold if needed.
4. Inflation Risk
Inflation risk is the risk that the purchasing power of your money will decrease over time, eroding the real value of your investments. You can reduce this risk by including inflation-linked bonds or investing in equities, which have the potential to grow at a rate that outpaces inflation.
5. Currency Risk
For expats, currency risk can play a big role if you’re investing in assets priced in a currency different from your own. Fluctuations in exchange rates can impact your returns. Mitigate currency risk by diversifying across currencies or considering currency-hedged investment options.
Attitude to Risk vs
Capacity for Loss
A common misconception among investors is confusing their attitude to risk with their capacity for loss. While they may sound similar, they represent different concepts:
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Attitude to Risk refers to your personal comfort with investment volatility. Are you someone who is willing to ride out market fluctuations, or do you prefer to play it safe, even if that means potentially lower returns?
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Capacity for Loss refers to your financial ability to absorb losses. Even if you have a high-risk tolerance, you might not be in a position to take on significant losses, especially if you rely on your investments for essential expenses or short-term goals.
We can work with you to balance these two factors, ensuring your portfolio reflects both your emotional and financial capacity to handle risk.
Matching Investment Type to Your Time Horizon
Selecting the right investment depends heavily on how long you plan to hold that investment. Your time horizon should guide your risk strategy:
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Short-term (1-5 years): If you need access to your funds within a few years, a more conservative approach is wise. Investments like cash, short-term bonds, or conservative bond funds provide stability and liquidity, helping you avoid significant losses due to market volatility.
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Medium-term (5-10 years): For goals in the medium term, such as buying a home or funding education, a balanced mix of bonds and equities can offer a good compromise between growth and security. Diversification is key, and adjusting your portfolio as your goal approaches can help lock in gains and reduce risk.
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Long-term (10+ years): If your investment goal is for retirement or long-term wealth accumulation, you can afford to take on more risk with equities, which have historically provided the best returns over extended periods. Over the long term, stock markets tend to recover from downturns, so the ability to stay invested through market cycles is essential.
Risk is an inherent part of investing, but it doesn’t have to be something to fear. By understanding the different types of risk, managing your investments according to your time horizon, and balancing your attitude to risk with your capacity for loss, you can build a portfolio that meets your financial goals while providing peace of mind.
At My Intelligent Investor, we specialise in guiding clients through these decisions, ensuring that your investments are not only aligned with your risk tolerance but also optimised for growth.
The Cost of Delay and the Danger of the Status Quo
Two hidden risks in investment decision-making are the cost of delay and the status quo bias. Many cautious investors put off investing because they are waiting for the “perfect time” or they stick with familiar, underperforming assets out of comfort.
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Cost of Delay: Waiting to invest, especially over many years, can be costly. By delaying, you miss out on the power of compound growth, which is one of the most effective ways to build wealth over time. Even modest, consistent investments made earlier often outperform larger contributions made later.
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Status Quo Bias: Clinging to what feels familiar, whether it's keeping all your assets in cash or only investing in industries you know, can be detrimental. A well-diversified portfolio not only reduces risk but also enhances your potential for growth. An experienced financial advisor can help guide you in breaking out of the status quo and identifying the right mix of investments that suit your overall financial plan.
Find out your Risk Score Today
Book in to complete our risk questionnaire to find out where you score on the five point risk scale from extremely cautious, cautious, balanced, growth to adventurous.
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Once completed, we will provide a report along with an appropriate risk-adjusted and diversified portfolio to match your financial planning needs.