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A beginner’s guide to risk appetite

We’ve all heard of the concept, ‘risk-reward’: when an individual is prepared to take a greater risk to receive a greater reward.

This notion remains relevant to this day, particularly when it comes to retirement investments. Such investments carry inevitable risk. That said, some carry more than others, and should be treated with more caution.

In some cases, pension planners seem willing to overlook the risk factor of many investments because the promise of reward is too tempting. Indeed, recent research from My Pension Expert revealed that one in eight (13%) of UK adults have moved some or all of their pension pot to a high-risk investment over the past five years, in order to increase its value.

There is a danger of savers focusing too heavily on the potential rewards, as opposed to the risk. Failing to fully comprehend investment risks, as well as one’s capacity for loss, could be detrimental to their financial futures.

As such, before any investment decision is made, it is vital for savers to determine their risk appetite. This may seem like an overwhelming task. But on the contrary, it is far simpler than many people assume.

Key considerations

There are three key points to bear in mind when calculating one’s risk appetite.

Firstly, savers should consider their personal attitude towards risk. They must consider, for example, how comfortable they would feel if they were to place part or all of their pension savings in an investment that is very sensitive to market fluctuations. If they would not be happy to do so, this would indicate that they may not be open to riskier investments.

Secondly, savers should consider their investment goals – this should take into account their investment timeframe, as well as their need for returns. This will help savers to determine how quickly they will need to see a return on their investment. Indeed, if someone requires rapid returns, their investment strategy will differ greatly from those who are willing to wait for ten years to access their cash.

Finally, people must factor in their own financial situation, and calculate how much they can afford to lose if their investment fails. So, if an individual would struggle to keep up with their household bills if a particular investment were to end badly, it is likely that their risk appetite would be lower than someone who may not feel as much of a financial hit in the same situation.

Of course, it is possible to calculate one’s risk appetite unaided. However, without in-depth knowledge about their finances, or indeed investments, it would be advisable to consult an expert.

The value of advice

As with any major financial decision, savers would be wise to seek independent financial advice – and the case is no different when it comes to pension investments.

Financial advisers will be able to conduct a thorough audit of a client’s financial situation, investment goals, and personal preferences to offer an accurate indication about their risk appetite. From there, an adviser will be able to make recommendations as to the appropriate investments to meet their needs.

At My Pension Expert, for example, our team of experts use a range of portfolios with varying risks to suit our client’s specific needs – from the appropriate level of diversification to tailored professional management.

Every investment comes with its own level of risk. However, it is important to understand what level of risk is compatible with each individual’s risk appetite. So, savers should think carefully about their finances, and seek advice accordingly, before making any major investment decision. Doing so will certainly help them to maximise their pension pot, without unnecessary risk.