What Is Investing?

What do you think of when you hear the words investment risk?

For most people, it’s probably the possibility of losing money.

Imagine investing £100,000 and opening your statement a year later to find it’s worth £85,000.

That doesn’t feel good.

Investment values can rise and fall and there may be times when your investments are worth less than you originally put in.

That’s certainly a risk. It’s just not the only one.

Some risks involve investments falling in value. Others involve money not growing enough, losing purchasing power over the long term, depending too heavily on one investment or running out while you still need it.

So perhaps a better way to think about risk is this:

What could stop my money doing the job I need it to do?

Once you ask that question, investment risk starts to look a little different. 

Same Fall, Different Consequences

 Imagine two people. Both have £100,000 invested and both experience a 15% fall, leaving their investments worth £85,000.

The numbers are identical. The consequences might not be.

The first person now needs to use most of their money in six months towards buying a house. If their investments haven’t recovered by then, they may have to sell while they’re worth less than expected. That could affect what they can afford to buy.

The second person is investing towards retirement, which is still 15 years away. They don’t need to sell now, so they have more time to withstand periods when markets are down.

That doesn’t guarantee their investments will recover or tell us how long any recovery might take.

Same investment. Same fall.

Very different circumstances.

You can’t properly understand risk without knowing what the money is for and when it might be needed.

A Fall Isn’t Always a Permanent Loss

There’s another distinction worth making. Investment markets move in value all the time. Sometimes those movements are small. Sometimes they’re anything but.

During difficult periods, share prices across large parts of the market can fall at the same time. If you own a diversified collection of those companies, the value of your investments may fall too.

That fall is real. Your investment is worth less than it was before.

What you don’t yet know is whether the fall will prove temporary or permanent.

Prices may recover over time, although they may fall further first. Nobody knows in advance.

Now imagine something different.

Instead of spreading your money across many companies, you invest a large amount in one business. That company gets into serious financial difficulty and eventually fails.

You could lose most or even all of the money invested in it. Waiting longer doesn’t necessarily solve that problem.

Both situations involve an investment falling in value, but they’re not the same.

A temporary fall in market value and a permanent loss of capital are both risks. They are different risks.

 Having more time before the money is needed can make a temporary fall easier to withstand because you may not be forced to sell while values are lower. That doesn’t guarantee recovery.

Time cannot rescue every poor investment.

Sometimes the Risk Is What Doesn’t Happen

Suppose you have £50,000 that you don’t expect to need for another 15 or 20 years.

You’re uncomfortable with the thought of its value falling, so you decide to keep all of it in cash.

Over the years, you receive interest and your balance grows. There are no sudden market falls and you can see more pounds in your account than you started with.

On the surface, that might feel reassuring.

The problem is that the prices of the things your money needs to buy may have been rising too.

If your money grows more slowly than prices rise over that period, your balance may be higher but its purchasing power will have fallen.

This is one of the less obvious financial risks: inflation.

That doesn’t make cash a bad choice. Cash can be appropriate for money you may need soon, for emergencies or for spending you don’t want to depend on investment markets to fund.

The point is that cash and investments face different risks. I explore the distinction in What Is Investing?

Avoiding one risk can expose you to another.

Don’t Let One Thing Decide Your Future

Imagine you work for a successful company. That company pays your salary and you also own shares in it. Perhaps part of your pension is invested in it too.

While the company is doing well, that might not feel particularly risky. Yet a lot of your financial life now depends on one business.

If the company gets into difficulty, you could face problems with your job, your shares and part of your retirement savings at the same time.

This is why diversification matters. I explore this in more detail in What Is Diversification?

Rather than depending too heavily on one company, industry, country or investment idea, you spread your money across many different investments.

Diversification doesn’t stop investments falling in value.

It reduces how much your future depends on any single outcome.

 You don’t know which company will perform best next year. Neither do I. We can form views about what might happen, but we cannot know the outcome in advance.

Diversification accepts that uncertainty rather than pretending we can reliably predict what comes next.

What If Nothing Goes Dramatically Wrong?

Investment risk isn’t only about market crashes or companies failing. Sometimes the bigger danger develops slowly.

Imagine someone retires with £500,000 invested and begins taking money from their investments to support their lifestyle.

There isn’t one disastrous year when they lose everything. Markets have good years and bad years, prices rise, spending changes and money continues to be withdrawn.

The difficult part is that nobody knows exactly how long their money will need to last, what markets will do, how inflation will affect their spending or what unexpected costs might arise.

Withdraw too much for too long and the money may eventually run out.

No dramatic investment disaster was required.

Running out of money is a risk too.

This matters because most people aren’t investing simply because they want the highest possible number on a statement. Their money has a purpose.

It might need to provide an income throughout retirement, help children or grandchildren, fund a future house move, allow someone to work less or provide choices later in life.

Once we look at risk this way, the question changes.

Instead of simply asking:

“Could my investments fall in value?”

We can ask:

“What could stop this money doing what I need it to do?”

Can You Take Too Little Risk?

This sounds like a strange question. Surely taking less risk must always be safer?

Not necessarily.

Imagine someone is 45 and building up money they expect to use gradually throughout retirement. They really dislike seeing the value of their investments fall, so they decide their priority is simple:

Never let the balance go down.

That might feel cautious. Yet the money may need to support spending many years into the future.

If avoiding investment fluctuations means the money doesn’t grow enough to keep pace with rising prices or support future spending, one risk has simply been exchanged for another.

Taking less investment risk doesn’t necessarily mean taking less financial risk.

That doesn’t mean taking more investment risk is automatically better. Taking more risk than you need, understand or can comfortably withstand can create problems of its own. This is something I explore in more detail in What Is Attitude to Risk?

The aim isn’t to take as much risk as possible, nor is it to take as little as possible.

The aim is to understand which risks make sense for what you’re trying to achieve.

So, What Is Investment Risk, Really?

When we talk about investment risk, we could be talking about several different things:

• investments falling temporarily
• suffering a permanent loss
• needing your money while investments are down
• inflation reducing what your money can buy
• relying too heavily on one investment
• withdrawing money faster than your resources can support
• taking too little investment risk to support your longer-term plans.

Some of these risks come from the investments themselves. Others come from how and when the money needs to be used. Both can affect whether your financial plan works.

Investment risk isn’t one single thing. Every financial decision involves trade-offs.

Keeping money in cash can protect you from short-term investment falls, but inflation can reduce what that money buys over longer periods.

Investing gives your money the potential to grow over time, but its value can fluctuate and returns aren’t guaranteed.

Diversification can reduce your dependence on individual investments, but it cannot prevent losses.

Taking less from your investments can help them last longer, but money is there to support your life too.

This is why simply asking “How risky is this investment?” doesn’t tell us enough.

We also need to ask:

• What is the money for?
• When might I need it?
• How much uncertainty can I cope with, financially and emotionally?
• What could genuinely stop my financial plan from working?

Investment risk isn’t simply the possibility that the number on your statement falls.

Ultimately, it’s the possibility that your money doesn’t do the job you need it to do.

Good financial planning isn’t about trying to remove every risk. That’s impossible.

It’s about understanding the risks you face, choosing which ones are worth taking and making sure they fit the life your money is there to support.

This article is for general information only and should not be treated as personal financial advice. The appropriate mix of investments will depend on your individual circumstances, objectives and attitude to investment risk.

Matthew Birkett
Chartered Financial Planner
Birkett Financial Planning