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Risk versus reward

It’s a central principle of investing – the higher the risk, the higher the potential rewards

There is always a degree of risk in owning investments. In extreme circumstances you could even lose all your money, so it’s natural to want to know exactly what the risks are, and which ones you should take.

How much risk should you accept?

Roughly speaking, the level of risk you might be prepared to accept depends on how long you can afford to tie up the money and how much you can afford to lose. If you’re planning to invest for 10 years or more you may be able to take relatively more risk in exchange for the possibility of higher returns.

Investment companies are primarily intended as long-term investments. You should be prepared to hold them for at least 5 years, and preferably 10 or more

How can you judge the risk?

Investment companies can have very different levels of risk. This depends on things like:

  • their portfolio and market diversification
  • the use of gearing (borrowing extra money to invest)
  • their various capital structures

Unfortunately, it’s not easy to make a precise assessment of risk. Markets are inherently unpredictable. Sectors that look unhealthy may start performing strongly and steadily, and companies that look dominant may suddenly reveal hidden weaknesses.

We’ve explained some of the risk factors you should look at lower down this page, but remember, it’s impossible to draw up hard and fast rules about the risk levels of a particular kind of investment company. You need to look at the whole picture, and might want to get an opinion from a qualified adviser.

Risk factors

  • Gearing
    Investment companies can borrow money to buy more assets, a process called ‘gearing’. They hope to make enough profit to pay back the debt and interest and leave something extra – but this doesn’t always happen, and they can lose money. The more an investment company borrows, the more risky it is.

How gearing affects performance

 

  • Volatility
    The price of shares can go up and down, depending on how the company’s doing and how healthy the market looks. The more the value of a share price moves up and down over a period of time, the more volatile it is. Generally, volatile shares are more risky.

 

What is volatility

 
  • Discounts and premiums
    More often than not, investment company shares trade at a 'discount' – you pay less for the share than the underlying assets are worth. Don’t assume it’s a good deal. Movements in discounts add an extra level of risk to buying investment company shares.

Find out more about discounts and premiums

Where to get advice on risk

You can get general information about financial services from the Financial Conduct Authority (FCA), previously the Financial Services Authority (FSA).

The FCA is an independent watchdog set up by the government to regulate financial services and protect your rights. It provides free and independent information about financial matters.

You can get free, unbiased money advice online, over the phone and face-to-face from the Money Advice Service.