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Understanding investment risk

Your risk profile is the amount of risk you're willing to take with your money and your capacity to deal with any losses. For example, if you lose some or all the money you invest, what effect would this have on your standard of living?

How do I decide my risk profile?

When you invest in funds you can invest in a range of assets. There are 4 main asset classes that funds can invest in:

  • Money market/cash
  • Fixed interest
  • Property
  • Equities

Each asset class typically has different characteristics and levels of risk and they can respond differently to changing economic conditions. You can also invest in funds that invest in a broad range of assets. These funds are known as multi – asset funds.

When it comes to investing generally the more risk you’re willing and able to take with your money, the more potential it has to grow in value over time. But taking more risk can also mean that there’s more potential for the value of your investment to fall. That’s because higher risk investments often carry a higher level of volatility. This means you could lose all or part of your money.

As we’ve shown each of the assets can have different levels of risk. Money markets/cash is typically lower risk while equities are generally higher risk.

However, even though an asset class has performed well in the past this doesn’t mean it’ll perform well in the future.

Risk levels

The funds that you can invest in are graded from 1 to 7 by the fund manager. Funds with a risk profile level 1 are the least volatile and funds with a risk profile 7 are the most volatile.

If you’re a cautious investor, you may only want to take a small amount of risk to try and achieve a modest or relative stable return. If so, funds that are less volatile might be more suitable for you.

If you’re more comfortable taking a larger amount of investment risk with your capital, you might want to go for funds that have a higher volatility. You might not worry about large fluctuations in the value of your investments because of the potential for higher returns.

How do I find a fund’s risk level?

You can find the risk rating of your chosen fund in the Key Investor Information Document’s (KIID) ‘Risk and Reward section’. It’s important that you read this before making any investment decisions.

Our example KIID provides an explanation of what to look out for.

The fund’s risk profile will be shown on a scale - like the example one below.

Whatever fund you decide to invest in it’s important to remember that the value of an investment can fall as well as rise and you could get back less than you invest.

If you’re not comfortable taking any risk with your money, then investing probably isn’t for you.

What other risks are there to consider when it comes to investing?

The fund manager measures the risk of the funds by looking at the volatility of returns. Some of the risks you may take when investing in funds can include but are not limited to:

  • Inflation risk – the return you get back from your investments could fail to keep in line with inflation, this means your money could be worth less over time
  • Exchange rate risk- if you were to choose funds that invest abroad the currency exchange rate can have an impact on your investment return
  • Liquidity risk – you might find it easier to sell some assets than others, for example funds that invest in equities are more liquid than funds that invest in property. That’s because property can take longer to buy, market and sell than equities.

You can find more detail on the specific risks that a fund is exposed to in the KIID’s ‘Risk and Reward section’.