Many investors assume risk is determined solely by their attitude to risk questionnaire or the label attached to their portfolio. However, in reality, investment risk can appear in many forms and can creep into a financial plan without people realising. We explain why you might be taking on more investment risk than you think and how to consider this in your financial plan.
“Risk comes from not knowing what you are doing.”
Warren Buffett
Risk comes in different forms
When most people think about investment risk, they immediately picture stock market volatility, such as the daily rises and falls reported in the news. But risk is far broader than this and it’s important that you understand its many forms. Knowing the difference between volatility and risk is essential if you want to build a financial plan that actually works for you.
Many successful professionals and retirees believe their investments are appropriately diversified, but hidden risks can develop over time. These risks are often overlooked because portfolio values have grown or certain assets feel familiar and comfortable.
Apart from market movements, there’s inflation risk, where rising prices erode the spending power of your savings. Interest rate risk for bond values and borrowing costs. Sequencing risk relates to the timing of income withdrawals, especially if there’s a market downturn in early retirement. There are liquidity risks, which relate to whether you can access cash quickly. There’s also a currency risk if you’re holding international investments.
Familiar investing doesn’t always mean safe
Many UK investors stick with a familiar strategy such as investing in domestic shares, property, or shares in their own employer. This comfortable approach can lead to concentration risk, where too much money is tied to a single sector, region, or company.
Concentration risk can build quietly, where a handful of strong performers grow to dominate a portfolio over time. The problem is that you might not even be aware of these changes. Should there be a significant market shift, a company-specific issue or another type of single negative event, this could lead to a catastrophic wealth loss.
Volatility and risk aren’t the same thing
When it comes to investing, short-term price changes can feel unsettling, but the biggest risk is the possibility of not meeting your financial goals. A portfolio with low volatility can still carry significant long-term risk if it fails to keep up with inflation.
Over the past few years, we have seen periods of high inflation in the UK. If you are holding too much in cash or low-yield assets, this might feel safe, but it can steadily reduce real purchasing power. If this is left unchecked, the resulting erosion can be as damaging to your long-term goals as the market volatility you’re trying to avoid.
Thoughtful investment risk management
Diversification remains one of the most reliable tools available to help you manage your level of risk. By spreading investments across a variety of asset classes, sectors, and geographic areas, you can reduce your reliance on any single source of return. Also, by looking beyond the UK, you can minimise your exposure to UK-specific economic conditions.
Over time, portfolios might drift from their original allocation as markets move. As an example, equities can often grow faster than bonds. Rebalancing helps you to maintain your intended risk level and supports a disciplined approach to decision-making. This involves periodically realigning your portfolio back to its target allocation.
It’s also worth being mindful of tax wrappers. ISAs and pensions offer valuable advantages, but focusing too heavily on one could impact your overall risk exposure without you realising.
Risk tolerance versus risk capacity
In financial planning, it’s important to distinguish between risk tolerance (how comfortable you feel with risk) and risk capacity (what your financial situation can sustain). These two things don’t always align, especially if you’re approaching retirement or already retired.
At this point, sequencing risk becomes relevant because drawing income during a market downturn can do lasting damage to a portfolio. This could matter significantly for anyone relying on pensions, ISAs, and drawdown strategies.
Investment risk should be considered alongside your income sources, including defined benefit pensions and the State Pension. You will need to factor in potential liabilities against your time horizon and goals.
Lastly, behavioural risk is often underestimated. Emotional decisions, such as reacting to market headlines, can increase risk more than the underlying investments themselves.
Financial Planning, Nottingham
Markets will always rise and fall, tax rules will change, and your personal circumstances will change too. Therefore, arrange regular reviews with a professional financial planner to align your investing approach to your risk tolerance, capacity and your goals. If you’d like to talk through your investment strategy, we’re here to help.
At Balance: Wealth Planning, we have two investment portfolios with 10 risk levels, so you can tailor your investment strategy to suit your objectives. We can help you align your investment decisions with your financial goals.
If you need investment advice, get in touch with our financial planners.
Sources:
(Balance: Wealth Planning website & investment website)
https://www.fca.org.uk/publication/documents/investment-risk-pre-rdr.pdf
https://www.axis.bank.in/blogs/generic/what-is-portfolio-rebalancing
https://www.schwab.com/learn/story/rebalancing-action
https://nextsteps.finance/risk-management
