Investment Risk
Investment Risk is best explained as the degree to which a fund can rise or fall. It is the potential for upside or downside.
The Oxford English dictionary describes it as "The likelihood of loss" but in this context it is more accurate to say the likelihood of fluctuation - up or down.
It is important that you don’t think of it as ‘loss’. Nobody likes to lose money in pursuit of their gain but most are comfortable with fluctuation in pursuit of gain – it’s just the degree to fluctuation you are happy with.
Read the section on 'Why Invest?' to understand why everyone looking to achieve a return over inflation has to take risk.
Simple Risk Explanation:
A good analogy of this is to ask if there was a plank of wood in front of you rested on the floor with a £10 note at the end of it. Apart from feeling a little daft would you walk across and lift up the £10 note? The answer would clearly be ‘yes’ as the Investment risk involved would be zero.
If you were given the same scenario with the plank 50 feet in the air, between two buildings, would you walk across? The answer would be ‘no’.
If the figure placed on the end of the plank were increased to £30,000,000 would you change your mind or at least reconsider?
This is a simple analogy of ascertaining whether or not there is sufficient reward for risk.
Our Investment advisers risk-assess every fund in terms of what extra return it is likely to give for the extra risk.
There are many factors that can cause risk namely; interest rates, inflation, politics, currency/exchange rates, liquidity in markets, confidence and general sentiment; investment philosophy and the capabilities/skills of the fund manager.
Time is also a great healer. An investment that is to be held for 10 years will ride out many storms whereas a shorter term investor may not have time to recover from any falls particularly if they bought on an historic high.
Over time the most volatile sectors have produced the best returns - but with the most fluctuations however.
As mentioned above, your level of risk is important to help ascertain which investment vehicle is most suitable. On a cold basis, risk may be viewed as the amount of capital you are not concerned about losing during shorter-term valuations.
As markets rise and fall, the underlying value of an investment changes for the better or worse. Historically, over the longer term, all of this has been smoothed out.
For example: if we look at the FTSE all share index from 1969 to 2004, for any 5-year period, clients would not have lost any of their capital in 90.1% of cases, this figure increases to 100% over10 years, and drops to 77% over 1 year (source Hindsight).
How do we measure risk?
Standard Deviation
Our measurement of risk is via 5-year standard deviation. 5-year standard deviation is best described as taking the average performance of a fund over a period of time and measuring on average how much the performance deviates away from this mean. This gives the true volatility of the fund and measures the extra risk being taken in order to achieve the extra return. Often, 3-year volatility is measured. This is highly flawed in that, during a 3-year rising market, there can be low volatility.
By taking a 5-year period, often you take in the tails of economic cycles showing a fund at its best and worst periods.
Consistency
Each individual a fund achieves a score and this is then set aside. Each subsequent month it will achieve another individual score. As a consequence, over a 5-year period you have 60 accounting periods all with separate scores. The score is measured by decile ranking – i.e. ranking each fund in the sector in one of 10 divisions. This will give a true indication of the consistency of a fund. The higher volatile funds and those funds with little investment management tend to score 1 and 2 or score 9 and 10 as they swing violently, because they are simply not managed and are over-exposed in the wrong stocks. A good, consistent performer will have a decile score i.e. a score out of 10, in each of those months, at somewhere around the 3 – 5 mark on a consistent basis with the top two spaces being typically taken care of by the funds that swing in and swing out.
Sharpe Ratio
We also look at a number of other ratios to ascertain a client’s portfolio. When we look at a Sharpe ratio we are looking at how much return an investor is making over and above a risk free asset such as cash but also how much risk it is taking to achieve its objective.
Find out why many people switch their Investment adviser to Worldwide Financial Planning by calling 0800 0112825 or complete the enquiry form in confidence.
Worldwide Financial Planning – Investment Adviser of the Year, Ethical Investment Adviser of the Year
The Oxford English dictionary describes it as "The likelihood of loss" but in this context it is more accurate to say the likelihood of fluctuation - up or down.
It is important that you don’t think of it as ‘loss’. Nobody likes to lose money in pursuit of their gain but most are comfortable with fluctuation in pursuit of gain – it’s just the degree to fluctuation you are happy with.
Read the section on 'Why Invest?' to understand why everyone looking to achieve a return over inflation has to take risk.
Simple Risk Explanation:
A good analogy of this is to ask if there was a plank of wood in front of you rested on the floor with a £10 note at the end of it. Apart from feeling a little daft would you walk across and lift up the £10 note? The answer would clearly be ‘yes’ as the Investment risk involved would be zero.
If you were given the same scenario with the plank 50 feet in the air, between two buildings, would you walk across? The answer would be ‘no’.
If the figure placed on the end of the plank were increased to £30,000,000 would you change your mind or at least reconsider?
This is a simple analogy of ascertaining whether or not there is sufficient reward for risk.
Our Investment advisers risk-assess every fund in terms of what extra return it is likely to give for the extra risk.
There are many factors that can cause risk namely; interest rates, inflation, politics, currency/exchange rates, liquidity in markets, confidence and general sentiment; investment philosophy and the capabilities/skills of the fund manager.
Time is also a great healer. An investment that is to be held for 10 years will ride out many storms whereas a shorter term investor may not have time to recover from any falls particularly if they bought on an historic high.
Over time the most volatile sectors have produced the best returns - but with the most fluctuations however.
As mentioned above, your level of risk is important to help ascertain which investment vehicle is most suitable. On a cold basis, risk may be viewed as the amount of capital you are not concerned about losing during shorter-term valuations.
As markets rise and fall, the underlying value of an investment changes for the better or worse. Historically, over the longer term, all of this has been smoothed out.
For example: if we look at the FTSE all share index from 1969 to 2004, for any 5-year period, clients would not have lost any of their capital in 90.1% of cases, this figure increases to 100% over10 years, and drops to 77% over 1 year (source Hindsight).
How do we measure risk?
Standard Deviation
Our measurement of risk is via 5-year standard deviation. 5-year standard deviation is best described as taking the average performance of a fund over a period of time and measuring on average how much the performance deviates away from this mean. This gives the true volatility of the fund and measures the extra risk being taken in order to achieve the extra return. Often, 3-year volatility is measured. This is highly flawed in that, during a 3-year rising market, there can be low volatility.
By taking a 5-year period, often you take in the tails of economic cycles showing a fund at its best and worst periods.
Consistency
Each individual a fund achieves a score and this is then set aside. Each subsequent month it will achieve another individual score. As a consequence, over a 5-year period you have 60 accounting periods all with separate scores. The score is measured by decile ranking – i.e. ranking each fund in the sector in one of 10 divisions. This will give a true indication of the consistency of a fund. The higher volatile funds and those funds with little investment management tend to score 1 and 2 or score 9 and 10 as they swing violently, because they are simply not managed and are over-exposed in the wrong stocks. A good, consistent performer will have a decile score i.e. a score out of 10, in each of those months, at somewhere around the 3 – 5 mark on a consistent basis with the top two spaces being typically taken care of by the funds that swing in and swing out.
Sharpe Ratio
We also look at a number of other ratios to ascertain a client’s portfolio. When we look at a Sharpe ratio we are looking at how much return an investor is making over and above a risk free asset such as cash but also how much risk it is taking to achieve its objective.
Find out why many people switch their Investment adviser to Worldwide Financial Planning by calling 0800 0112825 or complete the enquiry form in confidence.
Worldwide Financial Planning – Investment Adviser of the Year, Ethical Investment Adviser of the Year
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