Posted by Ian Taunt in Latest insights category on 31 Oct 19
Having recently launched a new ‘portfolio risk score’ tool for users of our :review
service, I thought I’d take a closer look at investment risk and share with you some of the things we’ve learned about Willis Owen investors.
What is investment risk?
An understanding of investment risk is crucial to maintaining an appropriate long-term investment strategy. Risk can (and should) be interpreted in many ways. To some people, risk means the likelihood of achieving a return below their expectations, for others it could be the chance of losing money, failing to keep pace with the cost of living or failing to meet a specific target. What all of these have in common however, is that they relate to uncertainty.
Risk versus Reward
Investing always involves a degree of risk, it’s generally understood that the higher the risk you take, the higher the potential reward but also the potential for loss. What’s often difficult is determining where you should sit along the scale of potential risk and reward, and then determining where, in fact, your portfolio is positioned.
So how much risk should I take?
Deciding on how much risk you should take with your investments requires some thought. The key things to take into account are:
||Risk tolerance – how risk makes you feel. If you can’t sleep at night worrying about your portfolio then it’s likely you’ve taken on more risk than you’re comfortable with. On the flip side, if you’re taking too little risk, you could be disappointed by your returns or you risk inflation reducing the buying power of your money.
||Risk capacity – how much you can afford to lose. We all go into investing in the hope of making money over the long-term but, in taking on risk, we accept (to varying degrees) that our investments might fall in value along the way. Think about what it would mean for you if your investments fell in value and make sure your portfolio reflects this.
||Time horizon and objectives – If you’re investing for a longer period of time, you may be able to take on more risk in the hope of getting higher rewards, because you’ve got more time to recover from any downturns. The nature of your goals is also important – if you’re investing in order to build up a sum for a specific purpose, the potential of not meeting that goal might limit the amount of risk you’re willing to take.
||Knowledge and experience – Individuals with more financial and investment knowledge are generally more willing to accept investment risk. You don’t need to be an expert to start investing but you do need to be comfortable that you understand the nature of the investments you hold.
Once you have a view on how much risk you should be taking with your investments, the next step is to establish whether the risk of your portfolio is aligned. Our portfolio risk tool is designed to help users of our :review service to understand where on the scale of potential risk and return their portfolio sits. Based on certain assumptions, the tool measures investment risk using information about a portfolio’s volatility levels over time and provides a score of between 0 and 10 (very low to very high risk). (the risk tool can analyse most instruments held within a portfolio, if your portfolio holds assets of a more specialist nature the tool may not be able to return a score. If this is the case it’s probably worth looking in more detail what it actually does hold!)
So how much risk are you taking?
We used our portfolio risk score to analyse the portfolios of our investors and see how they compare. The average overall risk score was 4.1 out of 10 which falls squarely into what we’d consider to be the ‘medium risk’ category.
The chart below shows how all Willis Owen investors’ portfolios scored on the scale from very low to very high risk.
Whilst more than half of investor’s portfolios fall within the ‘medium risk’ category. It’s interesting to see that Willis Owen investors show a definite skew towards the higher end of the risk spectrum.
Given its relationship to investment time horizon, we’d normally expect the level of risk in people’s portfolios to reduce over time. Our data shows that in fact, investors in the 41 to 50 age bracket on average have the riskiest portfolios, more-so than those of lower ages who potentially have longer investment time horizons. As we’d expect, the risk level of investor’s portfolios then reduces gradually with age.
Is there a gender divide?
There have been numerous studies highlighting the degree to which men and women invest differently, so we were interested to see whether this was true in the case of Willis Owen investors.
In fact, and as you can see below, our analysis showed very little difference between the amount of risk our male and female investors are taking with their portfolios.
Portfolio risk scores for our male investors were, on average, 3.25% higher than those of our female investors.
We also looked at investor behaviour by UK region. Our investors in Wales had, on average, the lowest risk portfolios whilst those in the North East had the highest.
To be successful as an investor, it’s crucial that you understand and are comfortable with the level of risk you are taking with your money. Risk is a very personal thing and something all investors need to think about when building or reviewing their portfolio. Finding the balance that’s right for you is all part of the challenge and enjoyment of investing.
If you’re registered for our :review
service, why not check out your portfolio risk score
and find out how it works. We can provide a score for all but the most complex of portfolios. If you’re a Willis Owen customer but are not yet registered, what’s holding you back?! You can register here
*All data taken from Willis Owen risk score data 21st October 2019 based on analysis of 4,264 portfolios.