Work out how much risk you should be taking and find investments to match.
Your attitude to risk is a very personal and emotional thing. But when it comes to investing it pays to be objective too and think about how much risk you are prepared to take within the context of your financial goals and your investment time frame.
As a general rule, the longer you have to invest, the more risk you can afford to take. So, just as a twenty-something shouldn't be using a cash Isa to save for retirement, nor should somebody approaching their retirement be piling all their money into small technology stocks.
If you're more used to savings accounts that pay a pre-agreed rate of interest, paying money into an investment that could potentially see you lose money can be daunting. But this needs to balanced out against the risks of leaving your money in a savings account where it's highly likely it will lose value in real terms as its buying power is reduced by inflation.
For many cautious investors, not taking enough risk becomes a very risky strategy to employ. You may not lose money but you may not make enough to achieve your financial goals.
By the same token some adrenalin junkie investors may need to tame their strategy in the final years of their investment when their priorities should shift from capital growth to capital appreciation.
Find out how much risk you should take with our interactive quiz.
You are a very low-risk investor but should you stick with cash?
You fall into this category because you chose the most conservative answers for more than half of the questions.
There are a number of very sound reasons for choosing cash, however. You may, for example, only have a short period over which to invest. Gavin Haynes, managing director of Whitechurch Securities, says: “If you can’t commit to five years or more, cash is going to be your best option – other assets may be too volatile.”
Alternatively, you may need to establish an emergency fund. Before embarking on more advanced investments, you need to have a few months’ worth of expenses saved up in case of any unexpected outgoings. Cash is the only suitable asset for this, as you never know when you might need access to your money.
Again, some people may just not be able to face the thought of losing money, even in the short term. Mark Dampier, head of funds research at Hargreaves Lansdown, says: “It often simply comes down to whether you can sleep at night.”
However, there is a price to pay for conservatism. If you opt for cash, you need to be prepared for the fact that returns are going to be disappointing. In fact, some high street banks are currently offering just 1% on cash ISAs.
Think about your investment targets: do you need to set aside more money or, if your time-horizon allows, do you need to consider taking a little more risk?
You also need to think about the longer term. Equities can experience big falls, but they tend to outperform cash savings over the long term. In the vast majority of 10-year periods over the last 50 years have seen equities beat cash hands down. So you should at least be aware of the potential you could be missing out on if you decide to stick with cash and ignore equities.
Then there’s inflation. It’s not an immediate concern, but when it returns, cash will struggle to make significant gains. As Gavin Haynes says: “Cash is not a risk-free asset in times of inflation.”
If you do opt for cash, it’s worth finding the best available rate and make sure you always switch to a better deal as soon as your initial rate drops. Make sure you don’t pay any tax on your interest too by choosing a cash Isa.
You are a low-to-medium risk investor and should consider a mix of cash, shares, bonds and other assets in your ISA.
You may have fallen into this category because you gave the middle-of-the-road answer every time, in which case you need a balanced portfolio and you’re in the right place. However, it may also be because you have conflicting attitudes towards risk – for example, you may have a long time horizon and be looking for a good return but have concerns about risk generally.
If this is the case, before you start assembling a portfolio, you should ask yourself some questions to determine where you need to compromise. Think about whether you really need such a large return. Can you afford to put more investment in and accept a smaller return?
If so, you can compromise on return and opt for a cash ISA. If not, you may have to compromise on the risk you are willing to take and use equities, bonds or other assets.
Low-to-medium risk investors need to think about mixing asset classes like this to suit the level of risk they can handle. A useful way to build a mix of assets is with funds that already embody them. Haynes says: “Mixed asset fund funds offer a balance of equities alongside other assets, including cash and bonds.” Funds in the mixed investment 0-35% shares sector, caps their stockmarket exposure at 35%.
If you want a more bespoke mix, you can get an ISA with a fund supermarket provider such as Interactive Investor, or Hargreaves Lansdown. These will allow you to spread your investments across a selection of funds. So, you could pick a bond fund, an equity fund and
alternative assets such as commercial property. You can separately invest part of your asset allocation in cash, and mix and match the proportions depending on what suits you.
You are a confident investor and should consider an equity ISA.
You have fallen into this category because you gave middle-of-the-road answers to most of the questions, but some of your answers also indicated a willingness, ability or need to take on more risk. Before you invest, you should look at any question you answered A or B to and consider where your priorities lie – if, for example, you only have a short period over which to invest, equities are unlikely to be the right choice.
However, once you’re happy that equities are the best approach for you, you need to start out by building a core equity portfolio. Gavin Haynes, managing director of Whitechurch Securities recommends this should consist of a mixture of UK and global funds.
Any portfolio will need balance; it shouldn’t be entirely made up of equities. “You need to reduce the risk by diversifying over a number of asset classes, including fixed interest and commercial property,” advises Haynes.
You are a high-risk, experienced investor, who can look for more volatile opportunities within equity ISAs.
You have ended up in this category because you already have a diversified portfolio, are investing for the long term and have an appetite for risk. This means you’re likely to be prepared to take some gambles with your ISA allowance because you have sufficient investments and a safety net elsewhere in your portfolio to fall back on. So your ISA may include more speculative funds, investing in areas with tremendous prospects for growth but with the risk of great volatility – for example funds investing in smaller companies or those investing in emerging markets.
Beyond the realm of funds, you could also consider buying a self-select ISA and using it to buy specific stocks. This concentrates the risk even further, but is a useful option for those who regard their ISA allowance as a relatively small part of their portfolio.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
Sometimes known as a trading ISA, a self-select ISA gives investors full control over which assets to include in their ISA, allowing them to choose individual shares and bonds rather than investment funds. Aimed mainly at experienced investors and subject to the same investment limits of a regular ISA, a self-select ISA will usually be managed by a stockbroker on an investor’s behalf.
In the UK, stocks are fixed-interest securities such as corporate bonds and government gilts. In the US, stock is the most widely used term for shares; a diminutive of the term “common stock”.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
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