Probably the most important issue is your attitude towards risk. The level of risk which you may be prepared to accept as an investor is a key consideration in deciding on the asset allocation within your investment bond.
There are many different types of risk:
- The risk that the buying power of your capital decreases over time.
- The risk that you lose some or all of your money.
- The risk that the growth you experience is variable.
- The risk that you might get back less than you invested.
- The risk that you do not achieve your objectives.
- The risk that you lose out on potentially better returns.
Different asset classes have different risk profiles. The Golden rule is that risk and reward go hand in hand. It is important that any investment allocation matches your feelings and preferences in relation to investment risk. Hence your asset allocation needs to be commensurate with your attitude to risk.
The table below shows how different asset classes are graded in terms of risk and reward:
|Futures and Options
|Venture Capital Trusts
|Single Company Stock
|Emerging Markets Funds
|Specialist Funds (Technology, Healthcare)
|Far East (exc Japan) Funds
|UK Smaller Companies
|North American Funds
|European Equity Funds
|UK All Companies
|UK Equity Income Funds
|With Profits Funds
|Cautious Managed Funds
|UK Equity & Bond Income funds
|UK Corporate Bond funds
|Gilt and Fixed Interest funds
|Deposit Accounts (including cash)
The higher up the spectrum of risk you invest, the greater the opportunity for significant capital growth but correspondingly there is also greater potential for losses.
For how long do you want to invest the money?
Attitude to investment risk is often correlated to the to the term of the proposed investment, in other words the length of time for which it is held. In most cases, the longer the term of the investment, the lower the risk. In general, if you are likely to want all or a significant part of an investment back within five years of making the investment, then you should keep the money in some form of deposit account. There are some investments, particularly those with a guarantee, where a term is specified, and access to your money prior to the end of the term is either impossible or likely to incur costly charges.
For example, a UK equity fund might be considered a risk rating of 9-12 but that would be lessened if the term were to be longer – 10 years or so, or increased if the term were shorter, say 5 years. This is because the investor has longer to withstand the volatility of the markets over the longer term.
Risk ratings are also influenced by the overall spread of other investments. If an investment portfolio is already well diversified, this can allow for greater risk taking, particularly if a new investment is only a small proportion of an existing portfolio.
Establish your attitude to investment risk
We have devised a useful tool which can help you decide on an appropriate asset allocation which you will find in our Interactive Risk Questionnaire.