Your pension pot is something you will rely on in retirement. It is only natural to be wary of any risk when you are planning how you will build it.
But unless you understand investment risk and how it affects your planning, you could face a retirement funding shortfall. In fact, risk can be key to building the pension pot you need.
What is risk?
Many people think of risk as the chance of being defrauded. In everyday conversation, that may be true. But when we are talking about investments, risk takes on another meaning.
Risk to an investor means the volatility of a holding, the possibility that it will go dramatically down or up.
So, a high-risk investment, such as a share in a new technology company will be very volatile. It could be the next Google and make you a fortune, or it could sink without trace.
A low-risk investment might be a government bond. The government, Sterling and the entire economy would probably have to collapse before you lost your investment, and you know exactly the returns to expect.
Should you play it safe with your investment?
No investment is ever truly risk free. You could invest in safe, low risk, low volatility stocks and bonds and be almost entirely confident that your money would be safe. However, you would have to content yourself on a low return on your investment, and a pension pot that could be disappointingly small.
More risk could mean greater returns.
How does risk work?
The simple way to understand risk is to realise that it is priced in to any investment. In return for high risk, investors can expect higher returns.
The greater return you want, the more risk you’ll usually have to accept, and the more risk you take, the greater the chance of losing some or all your investment.
However, even with high-risk investments, you can reduce your chances of loss with a diversified portfolio. Some high-risk holdings will fall, but hopefully others will thrive and more than make up for any losses.
The key to managing risk is to arrange a portfolio made up of low, medium and high risk holdings.
Controlling your risks
Controlling risk is central to building the pension pot you want. If you are risk averse, you may need to invest more, or content yourself with a smaller lump sum. If you have an appetite for risk, you have a chance of enjoying ultimately higher returns, but you may need to keep your nerve when your holdings are on a price roller coaster.
Your attitude to risk should also vary over time.
In your 20s and 30s, you might want to make high risk investments, to try and build up your capital. You can afford to take more risk as your money has more time to recover from falls in the markets.
As you get closer to retirement age, you may want to increase the proportion of your low risk holdings to help keep you safe from any unpleasant surprises. Professional fund managers will do this automatically as their clients reach key life stages.
What should you do?
To understand your own attitude to risk and set up investments that reflect it, you need to talk to a professional. At Continuum, we help people of all ages find the investments and pension savings that are right for them. We would be pleased to do the same for you.
The value of your pension and investments can fall as well as rise and you may get back less than you invested.