Taking the fear out of risk

You have the power to be in control of the level of risk you take on your investments. While for many, risk feels a step into the unknown or perhaps a necessary evil, it really doesn’t have to be this way. Yes, there is always a level of risk with investments, but there are some very simple things you can do to help you manage your exposure to risk effectively, freeing you up to make the investments that are right for you.

The thing here is to better understand what level of risk you feel comfortable taking on. And strangely, when it comes to risk, the best starting point is establishing your capacity for loss. When thinking about investments, people – and many financial planners for that matter – tend to want to focus on the potential gains. That’s understandable, but by assessing how any investment losses would affect your financial status and indeed your emotional behaviour (anyone ever considered panic selling when the market takes a nosedive?), you will be in a much better position to make an informed decision about your level of risk.

Knowledge is power – or in this case, control

To do this, you will need to look closely at your financials – focus on how high your income is relative to your spending, what the value of your assets are (housing, investments, business) relative to your liabilities and spending and how easy it would be for you to reduce the amount that you spend both in terms of essentials and discretionary expenditure. You want to establish a really clear picture of your true financial situation.

Having these figures in black and white will help you better understand what losses are genuinely manageable for you and you never know, you may actually find you are comfortable with a bit more risk than you initially thought. Using this kind of knowledge to inform your investment decisions will make sure that you are in control of your exposure to risk. It’s all about going in with our eyes wide open.

We also always recommend having at least six months’ regular expenditure in cash for you to access in the event of an emergency. This will buy you time to think, allowing you to make informed decisions rather than give a knee-jerk response. Crystalising a loss by selling when the markets are falling, for example, rarely represents a good time to sell.

Try not to panic

And our experience of the markets over the past couple of years have proven to be a case in point. On the 23rd March 2020 the FTSE 100 fell  to 4,993.90 points from a record high of  7,534.40, just two months earlier, on 20th January 2020.

Not many people will have felt totally calm in those circumstances, but those with a clear picture of their finances and a bit of a financial buffer will have been more comfortable holding their nerve and not panicking…all of which will have paid dividends. The FTSE now sits back at c 7,000 after all.

For any of you that have felt shaken by the recent volatility, I would urge you to revisit your views on investment risk. The markets have always been and will continue to be volatile, but it really does pay to stay invested and not to panic.

This reminds me of a bedtime story. Two frogs fell into a bowl of milk. Having swum around the bowl, they realised that the edge of the bowl was too high and steep for them to get out unaided. The first frog, accepting that it was useless to waste energy by continuing to swim since that would not get him out of the bowl, gave up and drowned. The second frog persevered, refused to give in and gradually the milk turned into butter, until the frog was able to use it as a foothold to jump out of the bowl.