Over the longer term, investments could offer better returns than cash savings, but in trying to achieve higher returns this does mean more risk. When deciding how to invest your money, it's vital to understand the risk levels involved in different investments, and work out how much risk you're comfortable with. It's also important to consider how long you want to hold your investment; it's a good idea to invest for at least the medium to long-term (at least 5 to 10 years).
Your attitude to risk
When you’re considering investing, you'll need to think about both your attitude to risk and your ability to absorb losses. Some people would be very unsettled by the prospect of the value of their investments falling, while others would be happy to accept the risk of ups and downs in the stock market.
There are a number of factors that will affect your capacity to accept the risk of losses, including how long you intend to invest for, your age and health, your income level, your investment goals, the source of your funds, and how much of your total assets the investment represents. All of these will have an impact on the level of risk you should take when investing. For example, if your investment is funded by an unexpected windfall, you may be more willing to accept a higher level of risk than if you were using your life savings.
When it comes to making the most of your savings, ideally you’d want to beat inflation by achieving higher returns than you might get from a normal deposit account. We appreciate that you want to do this at a level of risk you are comfortable with.
Generally, the more risk you’re prepared to take, the greater the potential rewards. But everyone has a different attitude to risk, so here’s an overview of the main types of risk which you need to consider:
Interest Rate risk
If you save your money in a fixed rate deposit account for a fixed term you could find yourself getting a lower rate of interest than the market average if savings rates rise. However, if rates were to fall, your fixed rate could become more beneficial compared to other rates available.
Inflation risk
You are probably aware of the effect inflation has on your money. If you leave your money in an account receiving 2% interest per year and inflation is running at 3% per year, then although your capital (original investment) will have increased in value, its buying power has reduced by 1%.
Capital risk
A general rule of investing is that the higher the investment returns you want to achieve, the higher the risk you must be willing to take. That is because where high gains are achievable, there tends to also be higher volatility, which means that while your capital could grow significantly, it could also fall significantly.
You need to strike an appropriate balance between the risk to your capital that you are willing and able to take and the level of returns that you are looking for to reach your investment goals.
Market risk
This is the risk of a fall in the particular country's stock market where your money is invested. When a benchmark index, such as the FTSE 100, falls you will usually find that most shares are dragged down with it. Some fall by more than the average, some by less, but few will buck the overall trend.
You can consider investing gradually, for example on a monthly basis, as this may help smooth out big variations in the prices you pay. Similarly, if you are investing with a time horizon of at least five years then there may be opportunity to recover from any market losses. It is important to remember that you may not get back the original amount you invested if investment markets fall.
Performance risk
There will always be a variation in performance between funds with similar objectives due to the different assets selected by each fund. Funds aiming for relatively high performance can result in greater performance variations than those adopting a more conventional investment approach. The performance of your investment is not guaranteed.