How to judge what risk you take when you invest… and how to use it to your advantage

Julie Brownlee, Fsp Invest, 08 Jul. 2014

Tags: risk, investment risk, managing investment risk, asset allocation, asset classes, strategy, investments, investing,

When it comes to investing, it isn’t just shares that you can put your money into. As well as shares, you can invest in precious metals, bonds, property, commodities and alternative investments. And you can choose to keep some money in cash. When you invest, it’s important to understand the risk attached to each type of ‘asset class’. Let’s take a closer look…

Different investments come with different levels of risk

Different asset classes come with different levels of risk. You can measure investment risk by the standard deviation of an asset class’ performance. This reflects the volatility that the asset experiences, Phil Oakley in Money Week explains.

The higher the standard deviation, the higher the associated risk. And higher risk comes the chance of bigger rewards.

Let’s take a closer look at how this works with the help of an example…

How different asset classes behave

The table below shows you the different risks and returns of various asset classes in the UK over the past 26 years:

Table of asset class risks and returns

You can see that shares were the best performer. They gave the best return. But with that came higher risk. You can see this from the high standard deviation of 16.17%.

In contrast, bond and property gave less return on your money, but the risk was also less.

Gold gave a poor return on investment and had high risk. But gold is a form of portfolio insurance. It’s a good hedge to have in your portfolio should another financial crisis hit.

What this shows is that when you invest, you need to think about where you’re investing your money. If you spread your money across a number of different asset classes, you can reduce the risk you take on.

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It all comes down to asset allocation

This is asset allocation. By applying asset allocation to your portfolio, you can offset high risks assets with lower risk ones.

This type of strategy is a good way of reducing your overall investment risk and protecting your portfolio from large losses.

So there you have it, how to judge what risks you’re taking on when you invest and how to use it to your advantage.

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