Managing investment risk

A look at investment risk – how it can be measured using volatility and how diversification can help to manage risk.

Investment risk

Investment risk is the risk that you’ll lose money if the value of an investment goes down. Although we can’t predict the future, there are approaches we can take to help us understand what investing might be like and how we can try and spread risk.

Volatility

To see how much the value of a fund or asset moves around over time, we look at its volatility. This is a measure of how much the value of return varies from the average return, over a given period of time. The higher the figure, the more volatile a fund has been. The lower the figure, the less volatile a fund has been.

The volatility measure looks back at what’s already happened. Although, it can give an indication of the experience an investor might have in the future (if the fund continues to behave in the same way), it’s important to remember that it’s only a guide.

What affects a fund’s performance?

A fund's performance is influenced by many factors, such as the types of assets it holds and how their value is influenced by changes in the economy, inflation, exchange rates and so on.

The changes in the values of the assets held by a fund are key to its volatility. A fund that invests in assets whose value doesn’t fall or rise a great deal will usually have low volatility. This could mean that the fund has a lower potential for growth but also a lower potential for loss.

A fund that invests in assets whose value falls or rises a great deal will usually have a higher volatility. This could mean the fund has a greater potential for growth but also a greater potential for loss.

Diversification

Diversification is one way that could help reduce your exposure to volatility and investment risk. Put simply, it means spreading your investments across a suitable range of assets. Read more about the most commonly used types of assets in our guide to investing.

How it works

Diversification works by spreading your investment across different asset types and regions. If one area isn’t performing well, other areas will hopefully be performing better. In this way, diversification can offer a better chance of growth.

Ways to diversify your investment

There are many ways to diversify your investment and your adviser will discuss these with you. You can diversify by:

• Asset class – spread your investment across the four main asset types; cash, bonds, property and shares.
• Region – invest in the UK and overseas so that you’re not limiting your investment to one country.
• Industry – invest across a variety of sectors such as energy, financial services and healthcare, so you’re less exposed to one type of company.
• Investment style – create a balance of funds. Some could focus on growth opportunities and others on value or recovery. This creates a blend of companies with solid but average profits and those with the potential to recover and make stronger profits in the years ahead.

Speak to your adviser for more detailed information on volatility and diversification.

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