When it comes to deciding how to invest within your pension, you will inevitably see providers and advisers talking about ‘risk levels’. If ‘risk’ appearing in the same sentence as discussions around your hard-earned money gives you slight discomfort, you wouldn’t be alone in that feeling. However, no financial decision is entirely devoid of risk – including the decision to do nothing.
Engaging in any financial activity involves accepting a certain level of risk, but the level of risk can vary significantly depending on a range of factors. As a general rule of thumb, the more growth you are after, the higher the level of risk you will have to take (although there can be exceptions).
So, how do you know what level of risk is appropriate for you and your goals?
Assessing your risk tolerance
Capacity for risk is objective – it’s a person’s ability to absorb a fall in their investment value that will not have a detrimental impact on their standard of living. This can be crudely calculated by undertaking a simple cashflow analysis of your financial circumstances, but this will represent only a snapshot in time and should be revisited regularly.
To determine what level of risk is right for you, we must consider several factors. This may include:
- Stage of life
- Sources of income
- Personal financial goals
- Dependants
- Lifestyle
- Existing capital and assets
- Your attitude to risk
For example, your tolerance for risk is likely to be higher if you’re in a stage of life where you’re still earning a regular income. If you’re at or in retirement and your income from non-pension sources has either ceased or greatly declined, you’ll be working with what we call ‘irreplaceable capital’– in this instance, it’s usually pertinent to take less risk.
Although the connotations around the word ‘risk’ can imply a sense of danger, no good financial adviser will recommend a course of action that takes reckless gambles with your money or puts you in jeopardy of losing everything. As our founder James Baxter often says, “don’t bet the ranch”.
The purpose of assessing your risk tolerance is so that we can make sure you are not taking more risk than you can handle or than is necessary to achieve your goals. Equally, if your circumstances indicate that you can take a greater level of risk than you think, we can advise you accordingly depending on your aims. Perhaps it would better to think of it as ‘level of caution’. Our number one priority is to protect your irreplaceable capital and help it stretch as far as you need it to go with lowest level of risk possible.
Your personal attitude to risk
It’s not just numbers that factor into this assessment. Your personal, or emotional, attitude to risk is just as important in determining the level of investment risk that is appropriate for your portfolio.
Whilst some of us may have a stable personal attitude towards risk and remain undeterred during market volatility, others will feel very uncomfortable at the idea of potential losses, especially with their pension savings.
This is likely to be the most emotion-driven aspect of the process, but it’s an important one. Good wealth management should give you peace of mind, not add anxiety. It’s not going to help you sleep at night if you’re herded into a portfolio that takes more investment risk than you’re personally comfortable with (even if the numbers say that you can tolerate it financially).
On the flip side, some people may be comfortable taking more risk than the numbers suggest they can withstand! In either scenario, it’s important for your wealth manager to consider both your personal (or emotional) attitude towards risk and your capacity for risk together when assessing the appropriate risk profile for your needs.
How risky are we talking?
At Tideway our risk profiles range from Low to High. A Low-Risk portfolio will have less volatility, but your portfolio might just barely outpace inflation’s erosion of its spending power.
High-Risk Portfolios place more emphasis on long-term growth and will feature greater proportions of equity investments (these are the ‘stocks’ that usually come to mind when people think about investing). Equity is more volatile by nature, as the stock market moves on a daily basis in response to global markets. This creates high potential for growth, but equally a greater risk of volatility and loss of value.
Across the industry, it is not uncommon for firms to have their own approach to assessing risk and aligning that to an appropriate portfolio.
We also know that Tideway typically takes less risk, and reduced volatility, in our “medium” risk portfolio that many of our competitors.
For example, Aviva’s Relatively Cautious mixed asset pension portfolio holds 40% equities at the time of writing, compared with Tideway’s Cautious mixed asset portfolio which currently holds 25% equities (and always less than 35%). One company’s ‘Cautious’ is another company’s ‘Balanced’. Always take a look under the hood!
Why not just keep it in cash?
The risk of inflation means that the £100 in your pocket today is not the same as the £100 in your pocket five years ago. Aside from the new face on the notes, inflation erodes spending power over time.
Keeping savings in cash in the long term is rarely beneficial. Although the figure on the screen doesn’t change (or perhaps increases incrementally if you have a good interest rate), in real terms you are likely to end up ‘losing’ value as inflation strips away its purchasing power.
Cash savings are of course important for shorter-term goals, but they will usually be insufficient to achieve the growth required to sustain your lifestyle through the whole of your retirement.
What if my risk profile changes?
It probably will. It’s natural that your risk profile will change over the course of your lifetime. As we touched on earlier, your goals, attitude, and capacity for risk during your working years are likely to be quite different to what they are at or during retirement.
It is important, however, to remember that your funds will need to sustain your income requirements for a further 30-40 years after you retire (and potentially cover unexpected costs such as care later in life). Balancing healthy caution with appropriate opportunities for growth is key here.
Your wealth manager will review your situation with you on at least an annual basis and make adjustments as necessary, to ensure that your plan for retirement reflects your current position and works as hard as possible for you towards your future goals.
Whilst it’s never too late to start with retirement planning, it is true that starting as early as possible gives your funds the best chance of achieving sufficient growth to sustain your desired lifestyle in retirement.
What next?
There’s no blanket approach to be had when it comes to assessing the right risk profile for you. Get in touch with our expert wealth managers to discuss your needs and start the process of planning for retirement, no matter how far away it may seem.
Give us a call on 020 3143 6100 or fill in the form below and we’ll get in touch as soon as possible.
