How to Avoid Undue Investment Risk
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham.
Risk is commonly defined as exposure to danger, loss or harm. When it comes to investing, risk is inevitably involved. Yet here at Castlegate, repeatedly in conversations with clients here in Grantham, we appreciate the common desire to avoid unnecessary investment risk. This is absolutely right, and particularly keenly felt by those in (or approaching) retirement who want to preserve their wealth for the years after work.
What counts as unnecessary investment risk, however? Arguably, there is a high degree of subjectivity on this subject. After all, a very cautious investor might regard any kind of aggressive, long-term investment strategy as unnecessarily risky! In this article, our Grantham-based team here at Castlegate will be focusing on some of the key, unnecessary risks agreed upon by independent financial advisers. We hope you find this content helpful, and invite you to get in touch if you’d like to arrange a consultation with us regarding your own financial plan (at our expense):
Avoid poor fundamentals
The stock market inevitably fluctuates over time; as do funds which follow popular, mainstream indexes such as the FTSE 100. A short-term drop in performance is usually a terrible sole reason to pull your money out of a fund. However, poorly-constructed funds are often a disaster waiting to happen and so should be avoided.
The challenge, of course, is identifying in the first place those funds which have inadequate fundamentals. Such funds might indeed be in (or on their way) to deep trouble. A classic case of an “obscure” fund with poor fundamentals was the Woodford UK Equity Income Fund, which saw years of outperformance before its decline from 2017. Eventually, the fund dropped from a £10bn peak to less than £3bn, before it was closed.
Sifting through investments to check their fundamentals (e.g. cash flow and return on assets) can be a complex and time-consuming process, which is why it can help immensely to get the help of an experienced financial adviser.
Incorporate different asset classes
Almost everybody knows that you shouldn’t put all of your investment eggs in one basket. Investing thousands in one company, no matter how promising, is highly dangerous and unnecessarily risky. If the business fails, then you stand to lose all of your investment. Yet many people avoid this mistake and still make another one: investing only in one asset class.
A good example of this can be seen in Buy To Let empires. Whilst much praise is due to the hard work and dedication shown by such landlords to build up a portfolio of 20+ properties, such a portfolio is still inherently at risk. If the property market falls, then the whole portfolio is in extraordinary danger.
For most people, investing in a range of asset classes (e.g. bonds, equities and Real Estate Investment Trusts) is likely to help off-set some of the risks involved with each individual asset type. The precise blend will vary depending on your risk tolerance and investment goals, but a financial adviser can help you determine the appropriate mix for your portfolio.
Minimise/avoid active funds
After decades of research into the investment management sector, academic studies have essentially demonstrated that the majority of active fund managers consistently fail to outperform the market. Indeed, investors across the world now appear to be recognising this, moving increasingly towards passive investments as over $1tn has left US equity funds over the previous decade.
The logic of an active fund manager is fairly straightforward, but not proven by evidence: “Let us pick your investments for you, and we can move capital away from stocks which are about to fall and commit it towards those which are about to rise.” Unfortunately, timing the markets in this way rarely works and usually results in lower returns for investors. Indeed, only 23% of all active funds outperformed their passive counterparts in 2019.
One final way investors can hedge against unnecessary risk is to consider incorporating global investments into their portfolio, in consultation with a financial adviser. Similar to putting all or most of your investment eggs into one company or asset type, committing excessive amounts of capital to one market or national economy can also leave your portfolio vulnerable to local or regional economic shocks. Diversifying globally, moreover, carries the additional benefit of enabling you to access markets where certain countries might be particularly strong in one market (e.g. Japan with technology and robotics).
As mentioned at the outset, investing is never risk-free. Indeed, not investing and leaving your cash on deposit is not risk-free due to inflation and the low levels of interest payable. Each asset class carries its own particular downsides which must be managed appropriately. Stocks are vulnerable to “bear” (falling) markets, whilst bonds can be detrimentally affected by higher interest rates (as can property investments).
However, diversifying your portfolio in strategic consultation with an experienced adviser can do much to protect you from unnecessary risk exposure. Other areas such as avoiding poorly-constructed funds, moreover, are not always clear-cut but you do hold a lot of control.
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment initial financial consultation at our expense: