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All investments have some degree of risk. However, it’s that risk which offers the opportunity for greater growth than cash savings over the long term.
What is investment risk?
With investing, there’s always the risk that the value of your investments can go down as well as up, so you might get back less than you paid in.
Generally, the more risk you take, the higher the risk you could lose money.
Why take investment risk?
Investing carries more risk than putting cash into a savings account. But, over the long term, it offers the potential for greater returns than saving in cash. This is important as inflation can reduce the value of your savings over time, meaning the money you save today might not be worth the same when you withdraw it later.
Long-term risk vs reward
It can be worrying to see the value of your investments go down, especially during periods of market volatility where you may see the value of your investments move sharply downwards in response to global events.
However, despite dips in markets, over longer periods investments still tend to deliver a better return. What may seem like a dramatic drop in the value of investments may seem less significant when viewed over the long-term.
More potential to keep up with inflation
When the cost of goods and services goes up (inflation), it means you can buy less with your money as things get more expensive.
Growing the value of your money can combat this because, if it grows at the same pace as or above the rate of inflation, it will keep or increase its value in real terms. That means it retains its buying power.
If interest rates are low or inflation is high, you may find the interest you get on cash savings means your money grows at a slower pace than inflation. This is when investing may be the only way for your money to grow enough to retain its buying power.
Compound growth
If your investments grow in value, you can choose to reinvest this growth. That means adding the money you've gained from investment growth to your existing investments. This offers future potential investment growth not just on what you invested initially but also on the reinvested returns. If you keep making a profit and reinvesting, this could repeat year after year.
Known as compound growth, it can substantially increase the value of your investments over time.
A similar thing happens on cash savings (compound interest). However, because investments tend to grow by more than cash over the long term, reinvested investment returns are likely to be higher than the compound interest you’d get on cash savings.
Can you reduce investment risk?
When you invest, there are steps you can take to minimise – although not eliminate – some risk.
Diversification: spread your money
One way to help reduce risk is by diversifying your investments.
This means spreading your money across different types of investments. It can help make you less reliant on the performance of any particular investment because, if one performs badly, the performance of another can help reduce the impact of any losses.
Understand attitude to risk vs capacity for loss
Attitude to risk is how you feel about risk. If you’re not comfortable seeing your investments fall significantly in value, your attitude to risk is likely to be fairly low.
Your capacity for loss, meanwhile, is about how much risk you can afford to take with your investments without harming your financial stability – now or in the future.
Even if you have some idea of how comfortable you are with taking risks in your daily life, do you know how this might apply to investing? With 12 simple questions, Royal London’s risk profiler takes just a few minutes to complete. It then suggests which one of seven risk categories you fall into – ranging from very cautious to very adventurous.
Other ways to reduce investment risk
- Beware of scams
Have you been contacted out of the blue online or through social media about an investment opportunity promising huge returns? The rule of thumb is always that if it sounds too good to be true, it probably is.
- Do your research
Make sure you fully understand any investment and how you can take your money out. You may want to get professional financial advice. At the very least, check an investment provider’s registration with the Financial Conduct Authority and find out if the investment is covered by the Financial Services Compensation Scheme.
- Regularly review and adjust your investments
What works in your 20s when you start investing probably won’t be best for you as you approach retirement. Keep in mind your investment goals and timeframes and adjust your investments accordingly. If you don’t feel confident doing this, speak to a financial adviser.