Investment Risks

What are the risks associated with an investment programme?

When people talk about investment risk, they usually mean the possibility of losing some or all of their original stake.

This is only part of the picture. There are 3 main types of risk:

Capital risk

If you put your money into deposit-based savings, such as building society accounts, you know that you will always get back at least the amount of your original capital, thus, there is no capital risk.

With investments like shares and unit trusts, which are bought and sold in a market place, you cannot be sure of this, because their price may have fallen during the time you have owned them. Another less obvious threat to capital is where charges are deducted from that capital rather than from the return.

You also need to consider the standing of the organisation with which you are investing. If you lend money to the British government, it is very unlikely that the government will default and be unable to pay you back as promised.

However, if you buy the bonds or shares of a small company struggling to break into new markets, there is a distinct possibility of you losing all your investment if the company goes out of business.

Inflation risk

The big problem with deposit-type investments is that, over the long term, their returns tend to be lower than those from investments such as shares, and can be so low that they do not even compensate you for the impact of rising prices.

Thus, although you can be sure of getting back your original outlay, it may be worth a lot less in terms of what you can buy with it.

A few investments are specifically designed to protect you against inflation, but are not always the most appropriate choice.

In the main, if you are investing for the long term, you should consider investments either in shares or linked to shares (such as unit trusts) as a way of hedging against inflation.

The risk of being locked in (or out)

Accepting a fixed return over a set period or agreeing to a contract with onerous early surrender penalties can prevent you from benefiting from improved returns elsewhere. Equally, though, keeping your options open can mean that you have to accept falling returns when others have protected their position by taking on fixed-rate deals.