plonkee money an english-er's thoughts on personal finance

March 12, 2008

basic guide to Stocks and Shares ISAs part 2: all about risk

Filed under: investment — Tags: , , , , — plonkee @ 12:00 pm

the guide to Stocks and Shares ISAsFor a while now, I’ve had a trickle of requests for a basic guide to investing in UK Stocks and Shares ISAs.

As I want to go through things carefully, I’ve split all the details into several different parts, starting with thinking about yourself and what you want with the money, and moving into what there is available, and the nuts and bolts of products and investments. This is part 2 of the basic guide to Stocks and Shares ISAs.

Previously on the basic guide to Stocks and Shares ISAs:

  • introduction – what is the basic guide to Stocks and Shares ISAs about
  • part 1: all about you – why you want to invest, and how much money you have to play with

risk profile – how likely are you to withdraw the money in a panic?

If there are as many reasons for investing as there are investors, then there are equally as many risk profiles. The key thing here is to know yourself, and educate yourself. Your risk profile for your ISA investment should also be influenced by your goals for the money and the timescale.

There are some tools that can help you determine your risk profile, but as a first start try thinking about the following question honestly:

If this investment goes down in value, how worried would you be?

Add as many qualifiers as you like to your answer – it might depend on when it happens (e.g. when saving for Eton College fees, it would be ok whilst Edgar is 2 years old, but a disaster when he is 12), or on whether you are comfortable with the overall investment (e.g. things that I understand would be fine, but if I’m not sure how the investment works I’d be really worried), or on how much money is involved (e.g. if it’s a couple of hundred pounds that’s ok, if it’s a couple of hundred thousand pounds I’d be losing a lot of sleep).

Broadly speaking, I’d split people into three risk categories:

  • Adventurous – I am looking for excellent returns, and although I don’t want to lose money I’m prepared to accept that might happen.
  • Balanced – I’m looking for good returns and I’m happy with some short-term losses.
  • Cautious – I understand that no investment is risk free, but I am willing to accept reduced returns for increased security.

types of risk and mitigation

Some of the risks that you need to think about include:

  • inflation risk – the risk that your money won’t keep up with inflation
  • capital risk – the risk that you won’t get as much money back as you put in
  • opportunity risk – the risk that your money will be tied up if a better opportunity comes along
  • shortfall risk – the risk that you won’t have as much money as you need, the importance of this depends on the purpose of your investment

There are lots of ways of mitigating against risk. You can (and should) educate yourself to mitigate against the risk of the unknown. You can (and should) diversify to mitigate against the risk of bad luck. You can move your investment over time to mitigate the risk that it performs badly close to the time at which it is required. The important thing is to understand that risk exists and know the level that you’re comfortable with.

more resources

For more information on risk, what you need to consider, and how to cope with it, check out:

summary

We’ve discussed a little bit about risk, and you should be able to take a reasonable stab at categorising your own risk. This is really important when looking at investments, not understanding the risk involved is the biggest cause of unhappiness with investment performance.

still to come…

Coming up in the basic guide to Stocks and Shares ISAs:

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