What kind of risk taker are you?

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Your view of risk is central to the type of investment you choose.  People tend to get grouped in to three categories:

• Risk-averse: you will attempt to avoid risk
• Risk-neutral: you will accept a small amount of risk
• Risk-seeker: you will actively seek out risks

But of course it's not always quite as straight forward because, in all reality, you are probably more a mixture of the three with differing risk elements of your character appearing depending upon the subject matter and your current life circumstance.  For whilst you may be quite happy to sky-dive or bungee jump off the nearest cliff it might be a completely different matter when it comes to risk taking with your own hard-earned money.  You do need to keep in mind that risk and reward go hand-in hand - you can't have one without the other.  The greater the risk the greater the potential reward and at the same time - the lower the risk the lower the potential reward.

At the same time of asking yourself what kind of risk taker you are - it's also a good idea to think about what your attitude is to loss.  Nothing proves the point more than the question below;

Given the choice of the options below - which would you take?

• £500 guaranteed or...
• The gamble on a toss of a coin - heads you win £1000, tails you win nothing

Now it's more than likely that you would have taken the first option - a safe £500 in your back pocket.  Now try and think about these two options;

• A guaranteed £500 loss or...
• The gamble of a toss of a coin - heads you lose £1000, tails you lose nothing

Interestingly, you may have pondered more on your decision here and chosen the second option.  If you did then it's of no great surprise.  Quite often people's aversion to loss can actually overcome their aversion to risk - so whilst you might perceive yourself as a bit of a cautious Joe; when it comes to losing a significant amount of money you may suddenly find yourself prepared to take a bit of a risk. Risk is a very personal thing - a small amount of risk to one person may seem huge to another. 

You can be prepared to take a greater risk if...

• You want to maximise your return
• You are happy to wait a long time before you need to cash in your investment

You may need to be more cautious with your investments if...

• You're saving for the shorter-term

I'm a 'risk averse' investor

If you feel that you are unhappy taking big risks with your money then you should think about fixed rate bonds, government gilts, cash deposits such as fixed term savings to store your money.  Be aware that the potential for return is going to be lower than if you were to take more risk.  These kinds of investments are also better for you if you are very close to retirement age (say within three-to-five years)

Take a look at some of our most competitive Fixed Rate Bonds... click here.

I'm a 'risk neutral' investor

You may be happy to take a little bit of risk for the promise of potentially larger rewards, maybe you are at least ten years away from retirement or maybe you want to put money away as a longer term investment for your children - because of this you should be looking at unit trusts, investment trusts, shares as a potential place to invest your money. 

Find out more about the difference between investments in our 'Types of Investment' guide.

I'm a 'risk seeking' investor

If you're willing to take a risk and willing to potentially lose more capital than you put in for the chance of reaping the BIG rewards then you should be looking at Forex, Contracts For Difference, or spread betting.

• To read more on forex... click here
• To read more on contracts for difference (CFDs)... click here
• To read more on financial spread betting... click here

I'm not sure what kind of risk-taker I am

Risk can never be completely eliminated however one way to minimise the effects of an economic crisis on the value of your investment is to make sure your portfolio contains a mix of different assets.  This is called diversifcation and it will reduce the exposure of your investment to the extreme lows of the stock market.  If you put all your eggs in to one basket, you are taking a risk.  Different investments behave in different ways and are subject to different risks.  Saving your money in a range of assets helps reduce the loss, should one of your investments fall in value.  There is also a need to diversify within each type of investment.  This is especially important in the case of share and bond investing.  It is important to remember that all investments have a degree of risk.  Even choosing not to invest is risky.  The key is to get the right balance.  Most people need a mix of assets in order to achieve their goals.  The mix required depends on an individual's needs and circumstances.

What about the other types of risk?

It's not just about the type of investment you choose.  That's just one in a line of several 'risk-taking' decisions you need to be aware of.  Other risks to your investment come from:

• Share prices fluctuating
• Interest rates varying
• Inflation reducing the future purchasing power of your investments - When investing, beating inflation is an important aim - which means that investing in cash (fixed term savings accounts) - whilst great to hold your emergency money fund - may not beat inflation over the long term as a good investment.
• Other Share risks:
  • Individual risks say for example; if the company that you've chosen to invest in performs badly,
  • Market risk - this is the risk of a fall in the particular country's stock market where your money is invested,
  • Currency risk - if your money is invested in stock markets outside the UK then you will face currency risk because at the point you want your money back it will have to be converted back in to sterling so the exchange rate will affect the value of your investment.  This could work either way for you but you still need to understand that there is a risk to it, Also, if the business that you are investing in does business overseas - they will be affected by the exchange rates.
  • And finally you have what we term 'manager risk' - there is a huge variation between the performance of different managers of unit and investment trusts.
• Bond Risks; Bonds tend to be less risky than having a share in a company.  A government bond (or gilt) has the perception of being much less risky simply because a government is always expected to pay back in full.  Although this is a classic - less risk / less return scenario.  One of the main risks of a corporate bond is that the company cannot pay back the money at the end of the term (say if the company has become insolvent) or another example would be if you were entitled to a regular payment and the issuer cannot keep up with the payments - known as a default risk.
• Liquidity Risk - it may be difficult to cash in your investment quickly (if you invest in property as an example) or you may not be able to cash it in at the price you expect.  This is known as liquidity risk.

 

Want to read more on Investments?

Investment Guide | Types of Investment | Contracts for Difference | Share Trading | Unit Trusts Explained | Online Forex Trading

Author: KYM Editor

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