Understanding lower risk investments

Risk makes a lot of people nervous, especially when it comes to investing. After all, no one likes the idea of losing their money. But without taking some risk, growing your money can be difficult. If you have a cash savings account, you’ve probably experienced this for yourself.

So, if you're looking for a middle ground between the high risks of the stock markets and the lower growth of cash savings, you might consider lower risk investments.

Saving (depositing money in a cash account) and investing (buying assets that are hoped to grow in value or generate an income) can both have a role in a successful financial plan.

The spending value of cash investments depends on the the interest you're earning and how it compares to the rate of inflation. If your interest rate is less than inflation, then your spending value will reduce over time.

With the aim of beating inflation, some people choose to invest in a portfolio of stocks and shares or other assets with the potential for higher returns than cash savings. Doing this involves more risk. As the value of any investments can go down as well as up, which means you can get back less than paid in.

Investments go up and down in value over time, so it’s impossible to predict if they’ll be worth more or less than they are now at any point in the future. Investment risk is the term that describes this uncertainty.

One factor of investment risk is their value going up and down - this is called volatility. This can be due to the performance of companies, government policies like trade tariffs or stock market crashes. 

Higher risk investments are more volatile, so you can expect bigger swings in their value. Lower risk ones tend to go up or down by smaller amounts.

Another factor in investment risk is liquidity, which refers to how easy or difficult it is to sell an investment. A more liquid investment is easier to sell and should allow you to convert your money back to cash quickly if you need to. If an investment is less liquid (for example, commercial property such as a shop), it won’t always be possible to sell the property and convert your money back to cash.

No investment is risk-free, but there’s a huge spectrum when it comes to how much risk is involved.

Stocks and shares (also known as equities) are popular investments in things like pensions as they have the possibility of high growth over a long time. They sit in the higher risk bracket.

Fixed interest assets, which include UK government and corporate bonds, are an example of a lower risk investment. Government bonds are bonds issued by governments as a way to borrow money and similarly corporate bonds are bonds issued by companies as a way to borrow money. Government and corporate bonds pay an income to the holder of the bonds and then the full value of the bond is paid to the investor when the bond matures, or comes to the end of its lifetime.

With investing, the aim is to match your long term goals with the level of risk you're comfortable taking.

For example, a lower risk fund might invest mostly in fixed interest assets but not avoid equities entirely. Excluding equities would reduce the level of risk, but would also limit how much the fund could grow, and how much money you could earn from investing in it.

To manage risk while investing in some higher risk investments, investors use diversification.

Investing all your money in a single equity and so the shares of one company would be an unusual and very high-risk approach.

Instead, investors split their money between a wide variety of company shares and therefore equities from different industries, countries and regions around the world.

For example, multi asset funds invest in equities and bonds to help spread the risk of the fund across different asset classes.

The length of time that you’re investing for is another important factor in managing risk.

It’s normal for the value of your investments to rise and fall over time, so the value of your portfolio might increase in some months and decrease in others. But over several years, the value hopefully goes up. So, if you’re investing for the long term, you shouldn’t be too concerned about short-term dips in value, as you may well have time to get your money back and hopefully more.

However, if you need your money back quickly, short-term fluctuations will be a concern. If the value of your investments drops and you don’t have time to wait before selling, you could lose money.

If you need access to your money in the next five years, investing may not be suitable for you.

Some of the reasons you might choose a lower risk approach are if:

• You’re new to investing
• You don’t like the idea of your investments changing dramatically in value

Otherwise, you might choose a different approach or decide not to invest at all.

To reduce your risk level, there are three important rules to remember:

1. Choose a larger proportion of lower risk investments like bonds, rather than stocks and shares.
2. Choose investment funds or exchange-traded funds (ETFs) that spread your investments across different companies, sectors and regions.
3. Be willing to invest for at least five years.

An easy way to choose lower risk investments is to pick a ready-made fund that's rated as lower risk. Our direct investing platform offers this as one of four ready-made growth funds. All four funds are fully diversified, and the lower risk fund is typically invested mostly in fixed interest/bonds and cash. Within an Aviva Pension, we also offer a Universal Retirement Fund. It switches your investments to typically less risky ones as you get closer to retirement. To find out more, see what we offer through our direct investing platform.