Risk and return

Balancing risk and return in your investments

Almost all investments come with a degree of risk that you could lose money. Generally speaking, the more risk you’re willing to take, the more potential you have for seeing your investment grow in value over the long term. On the flip side, greater risk typically means a greater chance of losing money, particularly over the short term. Before investing, it’s important for you to work out how much risk you’re prepared to take, and weigh this up against the possible return you’re hoping for.

Generally, equities (company shares) are the riskiest asset class with historically the greatest potential for growth over the long term. Cash is the safest asset classes, but the least likely to keep pace with inflation. Investing in a mix of investments, countries and industries can be safer than investing in just one as falls in one investment can be offset by potential rises in others.

The illustration shows the relationship between the main investment types in terms of risk and return. It's just for illustration and shows that generally, you'd expect equities to outperform property, cash and bonds over the long term (five years or more) but you'd also expect the losses to be greater.

Of course, this isn't guaranteed and is just intended as a guide.

Simple risk bar chart

Understanding volatility

When talking about risk, investment professionals often refer to ‘volatility’. This is the degree to which an investment’s value rises or falls over a period of time. The riskier an investment is, the more volatility you should be prepared for. 

The chart below illustrates how the various different types of investment performed in terms of both volatility and return over the last 19 years.  

The potential ups

Emerging market shares are typically the riskiest type of investment. You can see below that these were the top performing investment over this period, but they were also the most volatile (risky). If you’d invested £1,000 in an emerging markets fund at the start of 1999, you might have had £7,059 at the end of 2017.

At the other end of the scale, if you’d invested £1,000 in cash over this 19 year period, you might have ended up with £1,713 at the end of 2017.

This is just an illustration, as past performance is no guide to the future. There's no guarantee that returns in the future will be similar.

Ups and downs of investments over long term

Ups and downs of investments over long term

Key:

  • Emerging markets shares
  • Property
  • Global shares
  • Global bonds
  • Cash

The possible downs

The chart above also shows you that emerging markets shares (the blue line above) can be very volatile, with some pretty extreme ups and downs over the period. In contrast, cash grew fairly steadily with very few fluctuations.

To give you an idea of the impact of this volatility, over the credit crunch period in 2008 and 2009 (the biggest market shock in recent times), emerging markets shares fell 44% from £3,750 to £2,091 between June and December 2008. Cash, on the other hand, did not fall at all in value during the crisis (on a month by month basis). All the other investment types suffered falls to a greater or lesser degree during the crisis.

How much risk can you live with?

The key to living with risk, as the 'Ups and downs of investments over long term' chart above shows, is often your investment period.

If you have a long period before your target retirement date, you can perhaps take the risk of your investments falling sharply in value but still have enough time to recover and, hopefully, be rewarded in the long-term with greater growth potential.

If your target retirement date is within five years or so, you may want to try and avoid any sharp falls in value and invest in less risky investments.

Your willingness to take on greater risk is determined by many factors - read our ‘5 things to think about when choosing investments’ for a few questions to ask yourself when assessing your appetite for risk.

Remember, the value of the investments that you hold within your pension pot aren’t guaranteed and you could end up with less than is put in.

Choosing your investments…

Take the time to look at the types of fund available to you in your workplace pension scheme:

  • Each fund offered by your workplace pension scheme has a fund fact sheet. These include a risk rating so you can assess each fund’s risk-return profile on a like-for-like basis. Log in to your plan to see the fund fact sheet(s) that apply to you.
  • Our TargetPlan Risk Profiler allows you to assess what level of risk is right for you. You can then view the funds that match this risk profile. Log in to find out more about the Risk Profiler.

Remember, the risk rating doesn’t take into account your individual circumstances so it shouldn’t be the only measure you rely on when choosing a fund. 

…and reviewing your investments

Once you've made your fund choice, it's good practice to keep your investments under review. Your appetite for investment risk and your personal circumstances can change, so it's a good idea to check regularly that you're still happy with the level of investment risk you're taking.

If you need help reviewing your investments, you may want to talk to a financial adviser. If don't already have one, you can find an adviser close to where you live or work at unbiased.co.uk(Opens new window)(Opens new window)(Opens new window)

Also see