Low risk investing

Are you a risk averse or a risk-taking investor? This is one of the first questions you need to ask yourself before setting up your investment portfolio.
There are typically three types of risk when it comes to investing: low risk, medium risk, and high risk . In this article we will explain the concept of low risk investing, the defining characteristics of the approach, and the options you can add to your portfolio.

What is low risk investing?

Low risk means choosing portfolio components and assets that are considered safer or less volatile than the alternatives. This may mean that you choose options that can offer predictable returns, such as bonds or dividend-paying stocks, as well as keeping a certain amount of money in cash.

Low risk investors are acting, first and foremost, to protect their capital. They will usually be prepared to accept lower interest rate payments in return for the comfort of knowing that they are highly unlikely to lose any money. By comparison, high risk investors accept that while their investments could result in massive returns, there is always a possibility that they could lose everything.

For example, early investors in a tech start up can become overnight millionaires if the company takes off. But the risk of failure in a crowded and changing market is high and these investments can just as quickly disappear if the company goes under. By contrast, many government bonds or cash savings accounts come with a guarantee that any losses (up to a certain amount) will be covered by your government or bank.

Traditionally, a low-risk approach involves:

• Focusing on bonds;
• Taking a balanced, diversified approach to your portfolio;
• Favouring reliable, long-term investments over volatile, short-term options.

Why do people choose low risk investments?

Low risk investments carry a degree of reliability about their returns, and play an important role in a balanced, defensive portfolio.

Your risk appetite will likely change over time, as you get older and your investment goals change. Younger investors often pursue more aggressive ‘risky’ options that can pay off in the short term, while their youth means that they can afford to start over again if they lose everything. Meanwhile older investors who are focused on capital preservation, generally prefer to take a lower-risk approach to their money.

Some popular low risk investing options

Bonds

These are units of debt that represent a relationship between the lender (you, the investor) and the borrower (the issuer of the debt). Each bond has a maturation date for the initial loan to be paid back to the holder with a variable or fixed rate of interest. Bonds can be sold by the holder if desired to add liquidity in case you need to access your cash early for any reason.

Bonds are used by companies and entities to finance their operations and achieve key strategic goals. The lowest level of risk comes from government bonds, which are backed by the state and are therefore considered to have a very low risk of default. However, they will typically come with very low rates, as low as 0.5% or less.

When choosing bond investments, it is always important to consider the bond’s credit quality to make sure that there is a minimal chance of default.

Cash savings accounts

These are accounts that offer a percentage of interest on your savings. Unlike bonds, your money can be withdrawn at any time, allowing you to retain liquidity. In the UK, all cash savings are backed the Financial Services Compensation Scheme (FSCS), which will cover any losses up to £85,000 per institution.

While this allows for additional flexibility, it is important to note that it has been many years since any easy access savings accounts have been able to beat the rate of inflation. This means that the real-world spending power of your money will deteriorate over time.

Index funds

Similar to a stocks and shares holding, index funds group together similar types of stocks and shares investments in one place. With one single investment, you can instantly diversify your money across dozens or hundreds of companies, effectively reducing your risk. Index funds allow investors to achieve cheap, lower risk exposure to the markets as they replicate the makeup of the market they are imitating.

How to assess your low-risk investments

Any investment portfolio should be reassessed at regular intervals, as your risk profile will change over time. If you are seeking to decrease the risk in your portfolio, or to build a low-risk portfolio from scratch, there are a few questions you should ask.

What is my real risk?

It is important to remember that there is no all-encompassing definition of ‘risk’. For example, it is possible to create a low-risk portfolio that is fully diversified but results in losses nonetheless, as a result of macro-economic conditions or logistical interruptions. Read the news and conduct your own due diligence before making any new investments, and you can manage your risk even better.

It's also important to understand that taking on too little risk can introduce inflation risk to your portfolio. The impact of inflation can be invisible because you can’t see how much less money can buy over time in a bank statement. However, buying less with the same amount of money can erode the spending power of hard-earned savings.

What are my investment goals?

Understanding your goals makes for better investment decisions. For instance, if you are near retirement and saving towards your pension, you may be more inclined to invest in low-risk investments.

Am I protected?

When your priority is capital preservation, it is important to check which protections are in place for your money, in the worst-case scenario that your bank goes into liquidation. Following the Global Financial Crisis, most governments added consumer protections to ensure that a certain amount of money will always be paid back to investors, even if the bank goes under.