When it comes to investing, you need to ask yourself how much risk are you prepared to accept for the potential of a return on your money?
Your money is placed in funds which invest in 'assets'. There are four main asset classes. Each one works in a different way and carries it's own particular investment risks. Fund managers buy and sell these assets on your behalf, with the aim of increasing their value over a period of time.
Take a look at each asset class to find out more about their potential for 'risk and return'.
Money market investments - low potential returns and risks of value falling
Money market funds invest in cash deposits, for example in a bank or building society account, or short term (normally less than one year) loans to raise cash. They are lower risk investments and are unlikely to deliver high returns.
Gilts and bonds - low-medium potential returns and risks of value falling
These are loans to companies or the UK government which provide an agreed rate of interest until a set date. Funds holding these types of assets tend to produce lower but more stable returns than shares. They can be used as part of a portfolio to balance out higher risk investments.
Property - medium-high potential returns and risks of value falling
Property funds invest in commercial property and aim to deliver rental income as well as capital growth. Depending on the market conditions, their value can fall quite sharply. They are therefore more suitable for longer term investing, giving them more time to recover.
Shares - high potential returns and risks of value falling
As a stake in companies, growth depends on several factors including how well those companies perform. Over time, they are likely to offer greater potential for higher returns, but with it greater changes in value. This is because they are volatile (their value can rise and fall quickly). While they carry the greatest risk, they may provide the greatest return over the long term (10 years or more).
Risk vs Return
The tendency of a particular investment to rise and fall in value is reflected in its 'volatility'. A more volatile investment will tend to see frequent and/or sharp rises and falls while a less volatile fund is likely to both rise and fall more slowly.
Higher risk investments are likely to fluctuate more in value over time – they may swing from being higher in value, to lower in value, more often.
Choosing a low risk investment means that your money is likely to fluctuate by smaller degrees but you are less likely to see higher growth. Such an investment will normally change less in value over a period of time. In real terms, it will be worth less if inflation is higher than the return you receive.
When investing, the general rule is that the greater the potential for growth, the more risks you may need to take.
You have to accept some level of risk when you make an investment but how much depends on what you want to achieve and how quickly you hope your money will grow.
Only you know what your goals are and how much risk you’re prepared to accept to reach them.
Depending on the funds you choose, the levels of risk and potential investment performance differ. There's always the risk that your money could be worth less than when it was originally invested. If you're investing in a retirement savings plan this would result in a reduced pension in the future.