Financial consultants always make sure that we’ve read the small print – so we all know that the value of an investment can go down as well as up, that past performance is no indication of the future potential of your investment. But what does this actually mean to you when you’re trying to avoid losing the roof over your head and the shirt off your back? Is it all about knowing the odds before playing the game?

Simply put, you cannot obviate risk when you invest; you can however

• understand the risk

• reduce the risk

• understand your risk profile

Understanding the risk

There are a number of types of risk that you should consider in the evaluation of your investment options. Your financial consultant can offer you all the investment advice that you need but if you understand the main risk types at their most basic level you will be better informed from the outset and will be able to make considered financial decisions.

1) Market Risk - the potential rise and fall of a stock price influenced by the level of confidence in

• the market

• the company

• the company’s industry

2) Interest Rate Risk – Falling interest rates will of course adversely affect cash investments and those who rely on interest income, but did you know that bonds and other fixed income investments lose value when interest rates rise? There is an inverse relationship caused by the fact that interest rate rises bring new investment issues with higher yields to market, this makes the older investment worth less. A rise in interest rates can also make doing business for companies more expensive and adversely affect the market’s confidence in the business or industry.

3) Inflation Risk – Inflation is one of the most influential forces on interest rates, see above. And an increase in inflation means the increased cost of living can simply wear away profits already made from your assets, income generated from your assets and the values of the assets themselves.

4) Credit Risk – this exists when an investor buys without guarantee; the level of exposure they open themselves to in relation to whether the counterparty will deliver upon expiry is their credit risk.

5) Default Risk – this exists in relation to a debtor failing to make payment.

6) Currency and Currency Exchange Risk – this is of consideration if you are investing in foreign goods/funds/currencies. You need to consider the value of the foreign currency in relation to your own at both the time of purchase and the time of encashment.

7) Timing Risk – most people hope to ‘time’ the market right when making an investment, and ‘bet’ on the fact that the value of their investment will continue to go up. But simply by following the trend and buying when the market rallies and selling when it moves down investors risk losing out and being surprised when the market suddenly turns when they least expect it.

Reducing the Risk

There are three main points to consider when looking at risk reduction and they are: -

1) Diversification of investment type and company

2) Equanimity during the life of your investments

3) Discipline yourself to the gradual introduction of you and your money into the investment market place

1) Diversification. If you take the approach of spreading your money between investment types and investment companies you spread your risk and protect yourself from any problem that could occur in one area – whether that be a bad patch for a given investment type, or the bankruptcy of an investment company. By further diversifying through asset class, industry, country and currency you can potentially further reduce your risk. The bottom line should be spreading your investment between cash, the stock market and fixed interest rate investment types.

2) Equanimity. By remaining patient and investing for the long term you can reduce your risk considerably, and any losses suffered in the short term can be reduced over longer holding periods of time.

3) Discipline. By taking a gradual approach to investing, and investing your money step by step you are less likely to suffer from mistiming your entry into the market. If you discipline yourself to investing regular smaller sums you will reduce the risk of buying high and will potentially improve your long term gains.

Understanding Your Risk Profile

To better understand your investment needs and build your investment portfolio your financial consultant should carry out a full fact find with you. This will help him to assess your financial objectives and your risk tolerance. He should then structure your investment portfolio accordingly.

Tax Consultants Guide 2004

The tax and financial consultants guide

The material provided by Tax Consultants Guide is for general information only and does not constitute investment, tax, legal or other forms of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.