How much risk with your investments should you take?

Chris Taggart, Investment Manager at Quilter Cheviot, explains how being too risk averse can be a risk in itself and why taking a realistic look at return potential is key to reaching your financial goals.

“I don’t want to lose money”. It’s probably the most common concern I hear from first-time investors. For the naturally cautious or risk averse, investing can be a daunting prospect, especially if they have no direct experience of it.

Much of my work as an investment manager involves guiding people through dilemmas like this and resolving the tension between how much risk someone is willing to take, and how much risk it might actually be prudent to take

The challenge, however, is that you often need to take risks when it comes to investing. Generally speaking, taking more risk is linked to higher returns. Failing to take enough risk can be a risk in itself, especially if you cannot reach your financial goals by the amount you’re saving alone.

This leaves some people with an internal conflict of sorts. On the one hand, they might not want to take much investment risk. By not taking risk though, they end up facing a shortfall risk. Much of my work as an investment manager involves guiding people through dilemmas like this and resolving the tension between how much risk someone is willing to take, and how much risk it might actually be prudent to take.

Need for risk vs. desire for risk

So how do we solve these conflicting aims? Having spent more than fifteen years working with investments, I would say education is my number one tool. People often see risk in binary terms – you are either taking it or not. The truth is more nuanced when it comes to investing. You can have a portfolio of either safe assets or risky assets, but you can vary the percentage allocation to these safe or risky assets, thus creating a tailor-made portfolio for you.

When we think about investment risk, we need to consider several aspects. Most people are familiar with assessing their willingness to accept risk, or the degree to which you are prepared to see your portfolio fluctuate in the short term. You need to be able to avoid panic selling as this can seriously hurt your long-term returns.

You also need to think about what you are saving for, your time horizon and your ability to bear loss. Those with pension investments, for example, are split into two very different categories. Those in the accumulation phase are buying assets ahead of retirement, while those in the decumulation phase are selling assets to fund their retirement.

The importance of time-horizon

This leads to very different approaches to risk. If you’re accumulating, you might have more time to recover from any market falls so be willing to take more investment risk than would otherwise be the case. Conversely, someone in decumulation might take less risk than if we were just looking at how risk-tolerant they were.

Related to all this is your ability to bear loss. As an investment manager, I have a regulatory obligation to assess how well someone can withstand a fall in their investments, and how it would impact their wider financial health. If you depend on only a small pension to supplement your state pension, for example, your ability to bear loss will be fairly low, with a consequential impact on the level of investment risk you should take.

Once people understand how this all works in practice, they are often more willing to adjust the level of risk they take, whether that’s taking more risk over a long-term time horizon, or taking less risk because their circumstances call for a greater degree of caution

Once people understand how this all works in practice, they are often more willing to adjust the level of risk they take, whether that’s taking more risk over a long-term time horizon, or taking less risk because their circumstances call for a greater degree of caution.

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Top Tip

Risk tends to be thought of in highly negative terms, but returns are your reward for taking on a degree of it. One of the most under-appreciated ways that professional advisers add value is in how they coax out your true attitudes – and present realistic forecasts which will tell you how much investment risk you need to take on. This needn’t be a lot, but it’s very worthwhile having a free discussion with a professional to see if you are selling your wealth short.

Lee Goggin - Co-Founder

Lee Goggin

Co-Founder

I’m risk averse, what do I do?

How does this work in practice though? Many clients don’t want to take too much risk with their investments, but who are looking to earn an income from their pension – typically 4% or so. While this might sound like a modest aim in the current environment, it is very difficult to get an income of 4% without touching your investment capital and not taking some risk.

So how do we square the circle? Broadly speaking, there are three options for clients in these circumstances:

This is generally not a good idea, as you put yourself in danger of seriously depleting your portfolio or running out of money.

 If your pension pots looks like it might not be enough to support you at retirement, you may want to consider contributing more or revisiting your planned spending in retirement, rather than taking more risk or contributing more. This is not a popular option for obvious reasons, but it is the safest. 

This is often received with nervousness, but it is often the most fruitful.

Understandably, people tend to be risk averse because they are less familiar with investing. My job as an investment manager is to get to know what people are comfortable with. Once I am confident they understand the risks they are taking – both investment risk, and the potential risk of facing a shortfall – we can begin to put together a suitable portfolio.

I’m a risk seeker, sign me up!

There are clients, however, who are willing to take more risk than they should. These cases are less common, but one particular example does spring to mind, that of a pension client who was very gung-ho indeed.

People’s attitude to investing is often shaped by their previous experience. This particular client’s experience of investing was very positive, so he was less concerned about the potential risks and risk warnings. He perhaps saw the legal warnings as more to protect the investment manager from being sued, rather than to protect his own investments. Nothing could be further from the truth. The regulator is very strict about making sure investment portfolios are suitable for a client’s individual circumstances, and rightly so.

The medium risk portfolio has performed well, however, demonstrating the value of having something to fall back on even if you do decide to take high risk with a small proportion of your overall wealth

After a discussion he decided to take a medium level of risk with his pension and also run a separate portfolio himself, investing only in small, higher risk companies. Unfortunately, he has subsequently lost a significant amount of his self-invested money. The medium risk portfolio has performed well, however, demonstrating the value of having something to fall back on even if you do decide to take high risk with a small proportion of your overall wealth.

Balance need for risk and desire for risk

From my time as an investment manager, I’ve had plenty of experience of talking to people about risk, and the different perception we all have of it. Any discussion you have around how much risk to take should always be just that, a conversation between two people. You need to understand what you want from your investments and how much risk you want to take. Your investment manager is obliged to assess your ability to bear loss and to generally provide education and advice on issues you might not have considered.

Thinking about how much investment risk to take is ultimately a fine balancing act, and requires careful consideration. You should not necessarily go with your gut feeling

Thinking about how much investment risk to take is ultimately a fine balancing act, and requires careful consideration. You should not necessarily go with your gut feeling; as we’ve seen, there are other factors to consider, including your ability to bear loss and the returns you might need in order to make up any shortfall.

Most wealth managers offer initial discussions without any obligations, and I would certainly encourage people to take that offer up.  After all, there’s no risk to just having a conversation.

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