INVESTMENT RISK & THE DIFFERENT CLASSES OF ASSET

An investor's need for income or growth (or both), their attitude to risk and the length of time for which they are willing to invest will guide which classes of asset should be used, and in what proportions, to construct a suitable investment portfolio. A summary of asset classes is listed below:

IG = investment grade (strong credit rating)
non IG = non-investment grade (weak credit rating)

A sensible financial planning approach over the medium to long-term (i.e. 5 years plus) is to create a reasonable spread of assets over the various asset classes. In the UK there is often a bias towards property as we are a nation of homeowners, but this is no bad thing particularly as buying a home is an effective form of saving.

However, it is important people do not get carried away with investing in property and remember the need for an overall balanced approach.

Investment risk is the risk that your investment will make a loss, or a profit. The greater the risk you take, the greater the potential loss or profit.

In general investors wishing to avoid risk will invest in building society savings accounts or similar such investments. However, whilst there is very little risk indeed that the investment will go down in value (as it would require the building society to go bust), there is a risk that the rise of inflation will reduce the buying power of that money.

The main objective of investors should therefore be to achieve returns that are ahead of inflation.

So how do the various asset classes, and associated investment funds, compare in risk terms?

INVESTMENT RISK RATING
1	Cash savings National Savings
2	Gilts Index-linked gilts	UK Fixed Interest With Profits Cautious Managed Distribution Balanced Managed UK Shares Income
3	Residential property
4	Corporate bonds (IG) Commercial property
5	Corporate bonds (non-IG) UK FTSE 100
6	UK FTSE mid 250 European	UK Shares Growth European American Japanese UK Smaller Co.s
7	American Japanese UK Smaller co.s
8-10	Emerging markets Warrants	Emerging Markets

Investment risk can also be affected by the length of time that you invest. For instance, investments in shares are very volatile, and can rapidly go up and down in value during one week. However, after say 10 years or so, the amount of growth that is usually generated by investments in shares is so much greater than the short-term volatility, that the volatility becomes far less important.

Investment risk can also be affected by the format of your investment. For instance, you might make a one-off lump sum investment, or regular monthly premiums. If you invest regular monthly premiums into shares, some months you will be buying shares at higher values, other months at lower values. Over say 5 years or so, the cost of buying shares is averaged out, whereby the cheaper shares purchases help to compensate for the more expensive ones. This is a recognised statistical effect known as 'pound cost averaging', which normally benefits investors making regular savings over the medium to long-term. Therefore, there is greater investment risk associated with making a one-off lump sum investment, compared to regular monthly premiums.

For details of our Financial Planning Service click here.