Understanding Investment Risk
A guide to the risks of investing and how to manage them
In everyday life, if you saw a sign warning you about a risk ahead, you’d probably choose another route. A lot of people treat investment risk the same way. When we asked 235 Zopa customers why they don’t invest, 27% told us it was the risk or uncertainty that put them off.
But here’s the thing: investment risk is an essential part of the financial system. It’s what gives your money the best chance to grow. Avoiding risk entirely could hold you back from achieving your financial goals. The trick isn’t to dodge risk, but to understand it and keep it at a level you’re comfortable with.
What is investment risk?
Investment risk is the possibility that an investment could make a loss rather than a return, which could mean you’d get less money back than you put in.
If that sounds scary, it’s partly because it’s quite vague. We haven’t told you the size of the possible loss, how likely it is, or why it might happen. It’s easy to imagine that big losses are common or unavoidable, but that’s not the case.
A few things to keep in mind:
A dip in value isn’t actually a loss – not until you sell. The real risk is selling when prices are down and locking in the loss for good. We’ll come back to that later.
Diversify. You can reduce risk by making sure you spread your money across a wide range of investments.
Hold for the long term. Most losses are temporary, so you can often recover them by staying invested.
We’ll come back to each of these in a moment.
Managing risk through your investment mix
In general, the bigger the potential return, the bigger the risk. Here’s how that plays out across the main asset classes:
Cash has the lowest risk – you’re very unlikely to get back less than you put in. It also offers the lowest long-term growth, as returns can be close to zero.
Bonds (and other fixed-interest investments) are also relatively low risk, with slightly higher potential returns than cash.
Shares (and other equity investments) go up and down in price frequently, sometimes dramatically. That means high returns are possible, but short-term losses are more likely.
By combining these in different proportions, you can build a portfolio that’s tailored to the risk level you want. This technique is called asset allocation.
It’s sensible to keep some of your money in cash. If you want to keep your risk level very low, you could keep most of your money there.
If you’d rather aim for some growth without too many ups and downs, you could lean more into bonds.
And if you’re comfortable with more volatility in return for higher growth potential, you could add more shares.
Diversify to minimise risk
Some risks are specific to a single investment, and produce losses or returns that aren’t reflected in the market overall. There’s a simple way to reduce this risk: spread your money across a wide range of investments. This is called diversification.
This is different from asset allocation, which is about the broad mix between cash, bonds and shares. Diversification is the next layer down – spreading your money across many individual investments within each of those categories.
In practice, that means spreading across asset types (bonds and equities), different countries, different industries and different companies – so a problem with any one of them doesn’t pull everything down.
If you’ve chosen at least 20 investments and they’re sufficiently different, a loss on any one of them is likely to be balanced out by gains on the others over the same period.
If you’d rather not build the mix yourself, a ready-made multi-asset fund does the hard work for you. Zopa offers two – Balanced (lower risk) and Bold (higher risk) – so you can pick the one that matches how you feel about ups and downs and your money is automatically split across different investment types.
Remember that with all investments, your capital is at risk. To find out more about Zopa's investment funds, read our guide: Balanced vs Bold: which fund is right for you?
Recovering losses by staying invested
Higher-risk investments go up and down in value more – but only occasionally do they go down and stay down. Whether it takes a week, a month or a year, losses can often be recovered if you stay invested. This technique is called buy and hold – you can learn more about it in our guide, My investments have gone down – should I sell?
Many investments have a minimum recommended period of around five years because we don’t know exactly when losses will happen or how long they’ll take to recover, so ideally you’d be able to wait even longer, in case a dip lines up with when you were planning to take your money out.
To give yourself that flexibility, it’s worth keeping enough money in cash to cover any unexpected expenses (around 3–6 months of essential outgoings is a common rule of thumb). That way, you won’t need to touch your investments until the time is right.
Deciding how much risk you’re comfortable with
Put these three techniques together – asset allocation, diversification and buy and hold – and you can invest at almost any level of risk. You can start very cautiously, you can be more adventurous, or you can take a balanced approach in between.
When you’re working out what you’re comfortable with, there are a few factors worth thinking about:
Your emotions. Some people feel uneasy watching their investments change in value. Others see the ups and downs as part of the growth story.
Your experience. Someone who knows a lot about equity investments might feel more comfortable with the risks than someone new to them.
Your goals. Someone aiming to grow their money by 5% probably wouldn’t want to take any more risk than they need to.
Your timescale. Someone investing for decades has more time to recover from losses than someone who needs their money back in five years.
Your income and savings. Someone with plenty of disposable income (or savings to fall back on) might be happier putting some of their money at higher risk.
Your circumstances. Someone who owns their home outright with no dependents might be more comfortable with risk than someone with a mortgage and children.
If you’re finding it hard to decide, one option is to start with less risk and add more over time as your confidence grows. Or, if you’d rather have personalised advice, you can speak to a regulated financial adviser about your specific circumstances.
Ready to invest at a risk level that feels right for you?
A Zopa Stocks & Shares ISA lets you invest up to £20,000 a year tax-free, in either our Balanced or Bold fund. Explore the Zopa Stocks & Shares ISA.
Tax treatment depends on your personal circumstances and may change in the future.
