Understanding Investment Risk
When you invest your money there are a number of risks. The most obvious is when you put money in a bank or building society and the interest you receive is lower than the increase in the cost of the things you buy. This means the value of your savings is decreasing by the difference in the interest you receive and the increase in the cost of what you buy.
When you invest your retirement savings you have a wider choice in where to put your money. Each type of investment has different risks, which will affect the value of your savings and how much income you will have for your future.
To help you understand how each type of investment works and the risks of each, we’ve looked at what’s happened in the past. Of course, we can’t see into the future and there’s no guarantee of what will happen tomorrow. One thing to be aware of is the value of investments changes each day and you will see them go down at times – this is normal. If you’re saving for a long time, it’s best not to panic when this happens.
This information and guidance won’t provide all the answers and is not advice or a recommendation that any particular course of action is better or more suitable for you. You are responsible for your own investment decisions.
You should make sure you understand and are comfortable with the risks with each investment before you choose them. If you are uncertain about your choices or your attitude to risk, you should consult an Independent Financial Adviser.
Type of risk
When might this hit me the hardest?
How do I reduce this risk?
Inflation - The risk your money grows at a rate lower than the increase in the cost of buying the goods or services you need.
Over the short term (a year or two) this may have little impact, but if your pension pot grows more slowly than the increase in the cost of goods and services the real value of your money could drop. Over the long term this could be quite significant
Where you’re some way off (five years or more) using your savings to provide an income, you should consider investments designed to provide a return which keeps pace with or beats the increased cost of goods and services over the longer term - such as shares or property
Capital - The risk the value of your savings will drop
If you’re close (within five years) to taking an income from your savings, as there may not be enough time for the value to recover
Consider spreading your investments, to reduce the level of risk and/or if you’re very close to taking a lump sum at retirement, a fund not expected to lose much value - such as cash
Increased cost of an income - The risk the cost of buying an income goes up and how much you have to live on goes down
If you expect to buy a guaranteed income for life (an annuity) with your personal account in the next five years
The cost of buying an annuity is closely linked to, among other things, returns on bonds and gilts. Consider investments expected to change value in a similar way, so the value of your savings closely matches the cost - such as the Annuity Preparation Fund
Currency risk – this occurs when you have investments overseas and the value of the pound rises. It means you get less money back for each pound. A bit like cashing in left over holiday money and getting a higher rate to the one you had when you bought it
When the value of the pound rises against currencies of countries where you have money invested. For example, shares in companies in the United States
Consider spreading your investments across a range of countries, including the UK. You can also use investments where changes to the value of currencies has little or no impact - such as bonds, gilts or cash
Managing the capital risk
To help you select an investment to suit your appetite for risk, the Trust offers you a choice of funds. Each fund has been categorised to help you understand the level of capital risk.
These categories are based on the Trustees' current view on how much the value of each fund could fluctuate. The Trustees may change their view on the categorisation of each fund, if the level of capital risk changes in the future. You should keep an eye on your investments to ensure your choices still suit you, especially as you get close to your target retirement age.
In a nutshell:
- cautious risk funds are designed to protect your savings from significant fluctuations in value. These types of funds are, generally, more suited to people with fewer years to invest (less than 10 years) who have built up their retirement savings and are looking to protect them from a sharp drop in value
- moderate and high risk funds are designed to help your savings benefit from the growth potential of investing in shares, property and alternative assets, while understanding at times the value is likely to fluctuate by a greater amount than minimal or cautious risk funds. These types of funds are, generally, more suited to people with many years to invest (10 years or more), as there is still time to recover from sudden drops in the value of their investments.
High risk investments tend to be more specialised. They can fluctuate significantly in value because the risks are concentrated in one area, as opposed to being spread across different types of investment
Moderate risk investments seek to provide greater returns than cautious or minimal risk investments, but like high risk investments you could suffer sharp drops in the value of your savings. They mainly invest in:
- bonds with a higher risk of default; and/or property
Cautious investments tend to have a significant proportion of assets in bonds, gilts or bank and building society type investments. These investment options may hold other stock market investments, but their risks are mitigated by spreading the investment between asset classes
Investing in different types of assets
By spreading where your savings are invested into different types of assets, you can reduce the risk of only choosing one asset type.
The downside is, if one asset type, such as shares, performs better than the others, your savings wouldn’t grow by as much.
How your investments are managed
There are two ways funds are managed:
- Active - using this approach, fund managers buy and sell investments to maximise the gains and minimise the losses. To achieve this they anticipate market situations and take advantage of insights and opportunities as they arise. The expertise needed to run funds in this way means the investment management charge is usually higher than for passive funds.
- Passive - in contrast to active funds, a passive fund follows a stricter set of guidelines rather than trying to anticipate investment opportunities. Usually, a passive fund will aim to mirror the performance of a particular market index. The advantage of passively managed funds is their charges are likely to be lower than actively managed funds, as there are fewer research analysts and managers involved.
Whether the fund is active or passive, there is no guarantee the fund manager will achieve the objectives described.