By nature we are all risk adverse. Not even the most adventurous investor wants to experience total loss. We are however, every day, exposed to risk that we do not even know about. Saving in your local building society carries inflation risk and company risk. The bank run in 2008 demonstrated how a seemingly risk free environment became vulnerable to total loss. Investing is therefore about balancing the risk you are comfortable with alongside the potential rewards that you want to achieve. Establishing your comfort level for the amount of risk you are willing to take is crucial to any type of investment path you wish to pursue.
The more risk you are willing to take ie. into more volatile funds such as Equities and Specialist Funds including overseas investments, the more potential for fund growth can be achieved. However, spreading investments over a wide selection of funds varying in volatility i.e. Fixed Interest, Cautious and Balanced Managed funds together with a selection of Equity and Specialist funds, reduces total risk significantly. Your total wealth becomes less volatile having been underpinned by the stability of the less volatile funds.
Capacity for Loss
What is ‘Capacity for Loss’?
‘Capacity for Loss’ is the term given to the amount you could afford to lose on your retirement investments or capital without it affecting your standard of living. Understanding your Capacity for Loss will help you recognise what could happen if things did not go according to plan. In turn it will help you prepare and safeguard yourself from events out of your control. To plan effectively, it’s essential to have a detailed understanding relating to all the factors of your Capacity for Loss and how each of your investment options could be impacted by future events. This is especially true if you have low or no Capacity for Loss.
What’s the difference between Capacity for Loss and Attitude to Risk?
Your investments can go down as well as up and so there is always a risk that you could get back less than your initial investment. Your Attitude to Risk is the extent to which you are willing to accept the volatility that risk might bring to your investments for a higher potential return. Whilst your Attitude to Risk may not change, due to life’s circumstances, your Capacity for Loss does, so it’s important to review this every year with your adviser.