By our guest writer, finance journalist, Emma Lunn
If you’re making the move from saving money in cash to investing in other asset classes, it’s vital to understand risk. Your attitude to risk will influence which investments you choose and how big a proportion of your portfolio they account for.
All investments carry a degree of risk but some more so than others. In general, the greater the risk you take with your money, the greater the potential for growth.
At the lower end of the scale some investors won’t want to risk their capital under any circumstances and will look for low, but guaranteed, returns. Other people will accept risk to their capital if it means the chance of a higher return in the end.
One way to address risk is diversification. This means investing relatively small amounts in different assets classes, rather than a large amount in just one investment. Some people refer to diversification as “the 10% rule” – never having more than 10% of your money in one asset class.
Asset classes are simply different categories of investment. The most common are equities, bonds, property and cash.
Diversification helps spread risk as there is less potential for loss. For example, if you had all your money in property, and the housing market crashed you’d lose a lot of money. Or, more recently, if you had all your money in the Chinese stock market, the past few weeks would have seen you suffer some heavy losses.
You can diversify and spread risk further within asset classes. When it comes to stock, investing in individual shares is risky. Do you have the expertise and resources to consistently pick the winners? If you don’t then an equity fund, which includes stock from various companies picked by an experienced fund manager, is a good way to diversify and spread risk.
Peer-to-peer lending is a relatively new, and growing, asset class. Crowdstacker is one of a number of platforms that allows investors to lend money to credit checked and fully vetted businesses. It recommends that investors diversify their investment by splitting their money between several businesses or borrowers.
How much risk you want to take overall will depend on your goals and timescales. In general, the longer the timescale, the more risk you are safe to take.
For example, if you’re 30-years-old and saving for retirement at 65, you have 35 years to ride out your investments’ ups and downs. But if you’re investing for something in five years’ time, you may want a less volatile investment to meet your goals.
Perhaps the 10 per cent rule is not relevant to everyone in every situation but it is an interesting discipline to consider when looking at how you manage your money.
Investments are evolving! For information on the latest government reforms, including the new IFISA, click here.