Protect what you have: risk management

Finance can be complicated, but the fundamentals are simple: spend less than you earn and optimise your investments to achieve your goals.

Wealth protection is an essential part of investing. It's the art of keeping up with inflation and protecting the money that you already have without jeopardising any future returns. Inflation alone can erode the value of your money unless you intervene. We can’t do anything about costs going up over time, but we can do something to ensure our money can buy us the same lifestyle in the future.

Imagine you have a stockpile of £10,000 in cash, divided into piles of £100 notes. Each £100 note is used to pay your weekly bills. But after a year your costs go up and you need to take £110 per week from your pile of cash. A year later the same bills cost £120. You're taking more and more money from your stockpile, just to keep up with the cost of living.

When your goal is wealth protection, you will need to take a measured approach to investing. This is not the time to experiment with high-risk strategies, or ‘all-in’ investment approaches. Instead, wealth protection involves building a diversified, lower risk investment portfolio; a strategy most people describe as ‘defensive investing’.

What is defensive investing?

Defensive investing is about minimising any risk to your assets while protecting your capital from devaluation. Often this will involve accepting modest growth in the long term and little in the short. This is a very risk-averse strategy which makes it suitable for investors who are getting ready to live off their hard-earned gains.

In practice, this means balancing your portfolio’s composition to include low-risk stocks and fixed rate assets such as bonds or other dependable, long-term investments. Portfolios should be regularly re-weighted and should be highly diversified to weather any market disruption. As a result, defensive investing strategies require care and diligence to maintain.

What about risk?

Risk management is at the heart of all investment strategies. But when it comes to protecting your wealth, it's important not to overlook the very real risk of doing nothing and allowing your money to be devalued by inflation. Even the most risk-averse person should consider managing their risk by keeping a diversified portfolio with a mix of both cash and investments.

Before making any big investment decisions, it's important to understand your risk profile . There are three categories of risk: high, medium and low. Your risk profile may change over the course of your life as your financial goals shift, so it's worth revisiting it from time to time.

Investors with a longer time horizon may be more comfortable allowing for more risk in their wealth protection strategy, but wealth protection is usually a medium-to-low risk pursuit. You will not be chasing the highest returns on the stock market with a defensive, risk-averse portfolio. Instead, you will be relying on steady annual growth which can keep up with inflation, while benefitting from compound interest to help your money grow exponentially year after year.

Protecting your money from taxes

It can also be useful to explore different tax-free wrappers when pursuing a defensive investment strategy. For UK investors, this will mean taking advantage of the annual £20,000 ISA allowance, which allows all taxpayers to shield £20,000 per year within a stocks and shares ISA, cash ISA, or other form of ISA account.

Your tax liability will depend on several factors, such as your income, your investment earnings, and where you live. When wealth protection is a priority, it's essential to get to grips with your tax position so that you're not faced with an unexpected tax bill which could wipe value off your investment returns.

If you're unsure about your tax liability or the tax-free wrappers available to you, speak to a financial professional or do your own detailed due diligence.

The dangers of defensive investing

It's important to note that defensive investing is not for everyone. It’s typically a strategy employed by those who already earn or are about to earn an income from their investment portfolio.

It requires a lot of time and management, which many investors simply will not have the patience or the time to do. If this is the case, it could be useful to outsource your wealth protection strategy to a financial professional, but this too will require a good bit of research and due diligence to ensure you chose the right person or team.

And that is what sets wealth protection apart from other investment strategies. There are no short cuts here, and no easy fixes. This is an investment philosophy that takes time to master, and like all investing, it's never risk free. When your investments suffer a loss, you need to be able to decide whether you want to stay the course or diversify away from certain areas.

However, once you have a good understanding of your own risk profile, your investment goals, and the workings of the market, you will be well equipped to manage and protect your own money for as long as you like.