Risk, what a lovely word that is?
I am being a little sarcastic; risk to most people is not a lovely word at all.
However, I reckon that risk is a word that should not be used on its own. It should always be partnered up with the word “reward.
Risk and reward go hand in hand.
It was interesting to see recently that a FSA review identified that a very high proportion of the public are totally risk adverse. They simply don’t want any of it.
Yet many of them own “risk products” possibly without fully understanding what risk is all about.
I have on file a letter I once received from a client who wanted “no risk but a 10% annual return”. I am sorry to say we were not able to deliver that to him.
Risk and reward mean exactly that; if you want to benefit from a greater return that the proverbial “no risk” asset of cash (more of that later) then you have to accept that the value of your investment might well fluctuate.
Which brings us onto another uncomfortable word “loss”.
When most people say they are averse to risk what they really mean is that they are “loss” averse.
After all it is perfectly possible that an investment goes up and down in value but that does not constitute a loss (other than on paper). A loss only really happens when you crystallise the investment, by cashing in at an amount lower than the original investment amount.
Cash however is not without risk. Three that spring to mind are;
Inflation has the effect of reducing over time the real value of cash accounts. The future purchasing power of your cash savings will be lower, you will not be able to buy goods and services to the same value.
You might also be subject to institutional risk in the organisation that you save your cash with might go bust (thank goodness for the Financial Services Compensation Scheme (FSCS) – paid for by your intermediary and other financial institutions).
And of course there is the risk of lost opportunity. Another investment might produce a better return than cash and you will have missed out on that superior return.
So before you make any investment be that into an ISA or a pension fund or any other type of investment product, make sure that you understand the degree of risk, the degree of possible reward and the potential for loss.
And make sure that in respect of the latter item, loss, that you have the financial capacity to tolerate it.
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