Taking a calculated risk with your investments

Too often, the risk in stock market investing is a deterrent for aspiring investors. Who wants all those ups and downs with money they’ve worked hard to earn and carefully earmarked for their future? In reality, without risk, there would be no return and taking risk has paid over time. It just needs to be managed properly. 

The additional reward investors can potentially receive for investing in company shares over, say, cash or government bonds, is compensation for the higher risk they take. The returns from shares are influenced by the economic environment, risk appetite and the fortunes of individual companies. As such, they are far less predictable than for cash, where a saver gets back what they put in.

The long term real (after inflation) return from shares around the world (using data gathered between 1900 and 2017) has been just over 5% per year. That compares to 1.8% for bonds and 0.8% for cash.

These higher returns aren’t just a ‘nice to have’; they help ensure your savings keep pace with the rising cost of living over the long term. It is only by taking calculated risk that you can achieve a higher return on your investments, which is particularly important at a time of rising inflation.

This return is not achieved evenly, however. In the past five years, the MSCI World has risen 22%, 16.5%, 28.4% and 23.1%, but also fallen 8.2%. And as the early part of this year demonstrated, markets may drop precipitously at certain points. By 31 May 2022, the MSCI World had lost 12.8% since the start of the year.

Also, these are overall statistics for markets. Individual shares, commodities or other assets can be far more volatile. Investors in Netflix this year have seen its shares go from close to $600 to below the $200 mark, for example. It is this type of drop that can get investors nervous about risk.

The key to successful trading is taking a calculated risk. This means considering how much risk you want to take, can afford to take and need to take to achieve your goals. Finding the right balance will be finely calibrated. Taking retirement as an example again, you need to take enough risk to reach your retirement income goals, while not betting everything on a few racy technology stocks.

Things will also be influenced by your overall wealth. If you have plenty of income from elsewhere – say buy to let income – you can probably afford to be a little more daring with your investments in the hope of creating stronger growth. Those with smaller savings pots may not be willing to take the same risks.

It also needs to be the right level of risk for your financial goals and temperament. If too much variability in the price of your investment induces panic, it is worth re-examining your strategy. On the other hand, if you have plenty of time before you are likely to need the capital and are comfortable with the value of your savings bouncing around a little, it may be worth taking more risk to try and grow your capital faster.

These decisions are complex and may have a lot of moving parts. Equally, your risk levels won’t stay static over a lifetime: when you are young and have relatively few commitments, you can afford to take more risk than when you have a mortgage to pay and children, pets or elderly relatives to support.

Collective investment funds can be a good choice for the core of your portfolio. They can help diversify your investments and come in many different shapes and sizes, covering all the main asset classes. And going with a sensible, stable core for your portfolio doesn’t stop you keeping some firepower to make punchier trading decisions round the edges.

To manage risk, your portfolio should definitely cover more than one asset class, as each will come with a different risk profile. They may also react differently in different market conditions. Let’s take the risks in bonds compared to the risks of stocks (or shares) as an example. Bonds are generally lower risk, particularly government bonds and high-quality corporate bonds. So-called ‘high yield’ bonds tend to carry greater risk – these are corporate bonds where there is a greater risk of the company going bust.

Shares (or stocks) tend to be higher risk, but there is a vast spectrum – from companies such as Apple and Microsoft to small speculative software or mining companies. There are usually greater risks in emerging markets. These are early-stage economies with less established markets. It is also worth noting that the risks for stocks and bonds will change over time. Bonds are riskier at a time of rising inflation, while smaller companies are less risky when the global economy is in a growth phase.

Like we said, it’s complicated, but the right platform should help you access and research a broad range of investments effectively and so navigate the decisions you need to make. When it comes to making the most of your money, risk can be your friend rather than your foe. It just needs to be managed to make sure you’re taking the right risks at the right time.

The Fineco platform is designed for serious investors. You can access and research collective investment funds and individual stocks and bonds from many different sectors and 26 markets around the world.