Risks come and go depending on economic conditions and evolve over time. One very important risk at the moment is the risk that investors are losing value in real terms because they are over-exposed to cash when inflation is breaching the Bank of England’s 2 per cent target.
The FCA has found that of those with more than £10,000 in investable assets, nearly two-fifths do not have any investments at all and are holding all their assets entirely in cash. A further fifth were holding more than 75 per cent of their investible assets in cash.
Why is risk management important when allocating assets?
According to research conducted by Quilter and Boring Money back in 2018, DIY investors are missing out on up to 11.3 per cent of potential investment returns each year compared with a professionally managed portfolio because they suffer from seven investment ‘sins’. These are:
- Holding too few shares, or being ‘undiversified’
- A bias towards the UK, ignoring the opportunities in overseas markets
- Lack of asset allocation diversification, using only shares when other assets could help
- Overtrading, fiddling around the margins of their portfolios
- Panic selling, ditching all their holdings at the first sign of trouble
- Not rebalancing, losing out on the proven ‘Rebalancing Bonus’ returns
- Lack of pound cost averaging
Each of these seven deadly sins results from a failure in risk management.
While reducing risk often involves an action to be taken, potentially one of the costliest risks, that of panic selling during periods of market volatility, can be solved by simply doing nothing at all. This would have been painfully evident back in March and April last year as markets sold-off when the economic impact of the pandemic was becoming clear.
With red lights flashing all around, it takes great courage to resist the urge to sell-out and cut your losses. Sometimes doing nothing is the hardest thing to do at all, but history tells us that by doing nothing you will be rewarded. Anyone who sold out in March would have missed out on the subsequent recovery over the summer months and beyond.
What level of risk is suitable?
There is one general rule of thumb when it comes to determining an appropriate risk appetite. The longer the time-horizon someone is investing for, the greater the risk they should accept as they will have a longer time period to smooth out any short-term volatility.
But risk is also incredibly subjective, and there is considerable variation in people’s perceptions of risk. Some people are naturally risk takers, and some are more risk averse.
