Manage risk
Investing is about taking risks that you're comfortable with.
Understanding risk
It's important you understand and manage risk. This will help you steer clear of the more common investing mistakes. The first thing to learn is that risk isn't the same as volatility.
Volatility describes the natural rise and fall of markets - which isn't within your control. What you can control is the level of risk you're prepared to take when choosing your investments. This will depend on what your financial goals are, how long you want to save for and your personal circumstances.
Take the right risks
The theory
Ultimately you need to choose a level of risk that you feel comfortable with. The higher risk, the higher the potential returns. The lower the risk, the lower the potential returns. You need to think about how long you want to invest for and your personal circumstances - before deciding which level of risk might help you achieve your financial goals.
How it works in practice
Shares are at the higher end of the risk spectrum. But greater risk can lead to potentially greater returns. A balanced portfolio should include a mix of all these assets, rewarding investors for staying invested and riding out market ups and downs.
This example is for illustrative purposes only. In reality, investment values can fall as well as rise. Charges would also apply and reduce any returns. Past performance is not a reliable indicator of future returns.
Watch out for inflation
The theory
Inflation is a term that's used to describe rising prices. It matters because you can buy less with the same amount of money over time - which can affect the value of your assets over the long term. It's particularly important to factor in inflation when thinking about your pension pot. Your investments need to rise by at least the rate of inflation in order to maintain their value in real terms over time – otherwise it's unlikely that you'll be able to maintain the lifestyle you want for yourself.
How it works in practice
If you go to the supermarket, the same goods will cost you more than they did ten years ago. That's inflation. It's likely they will cost more in future too. So, if you want your pension to have the same buying power in the future as it does now, you'll need to take steps to mitigate the effect of inflation in the years to come.
Mix it up - diversification matters
The theory
No one can predict the future and that's particularly true of investing. It's impossible to know which asset class, country, continent or industry sector will perform best or worst in any given year. You can get lucky and pick the top performer one year. But the chance of you doing this consistently is pretty slim. It's much better to hold a mix of investments (the technical term for this is a diversified portfolio). Some will perform well at a time when others don't do as well, so they help to balance each other out to potentially give you a smoother ride over time.
Don't be forced to sell
The theory
Over time, markets rise and fall. This is only a problem if you need access to your investments at short notice and are forced to sell after markets have fallen - as you could lock in your losses.
Having some cash set aside - ideally enough to cover three to six months' living expenses - can help you wait out a market downturn and sell at a better time.
How it works in practice
The chart below shows what happened to long-term returns after the ten biggest FTSE 100 falls. While markets fell in the short term, returns over the following years were often positive.
While past performance isn't a guarantee of future returns, staying invested for longer has often helped investors recover from short-term market downturns.
Keeping some cash in reserve for emergencies can help you avoid selling investments during the worst market falls.
What are the main asset classes?
Also known as stocks and shares, when you invest in equities you buy a small stake in a company with the aim of capital growth, dividend income, or a blend of the two. When you buy a share in a company, you're actually buying a piece of that company. The investment return you earn depends on the success or failure of the company itself. Equity funds have the ability to invest in a range of companies, based on a particular fund manager's expert insight and experience, spreading the risk across a number of holdings and accessing multiple opportunities on your behalf.
Potential benefits:
- You could receive dividends (a share of earnings) to reinvest or provide a regular income
- Equities often hold the greatest potential for capital growth
Things to consider:
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As an asset class, equities carry the greatest risk in the pursuit of reward. They can prove volatile in the short term.
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The value of investments and the income from them can go down as well as up, so you may get back less than you invest.
Bonds are corporate and government loans with you playing the part of the lender, in exchange for interest payments over a set period. Through issuing a bond, a company or government can borrow money in exchange for paying a fixed interest over a set time period, along with paying the initial amount back at the end. When you invest in bonds you are the lender and benefit from regular payments over the life of the bond. You can also choose to invest in a bond or income fund or select a multi-asset income fund. These funds invest in various asset classes to generate an attractive income, diversified across a number of securities. The multi-asset approach also benefits from diversification among asset classes, with the intention of reducing the overall risk of the portfolio.
Potential benefits:
- Interest is fixed and paid regularly
- The value of a bond on the open market may go up
- Paying interest on bonds is a higher priority for companies than paying dividends
Things to consider:
- Corporate bonds can be less secure than government bonds and gilts
- The value of a bond on the open market may go down
- The value of investments and the income from them can do down as well as up, so you may get back less than you invest. For funds that invest in bonds, please be aware that the price of bonds is influenced by movements in interest rates, changes in the credit rating of bond issuers, and other factors such as inflation and market dynamics. In general, as interest rates rise the price of a bond will fall. The risk of default is based on the issuer's ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between different government issuers as well as between different corporate issuers.
A commodity is a basic good like steel or oil that is most often used in the production of other goods or services. You can invest in commodity funds, which will often include mining and production companies, or track the performance of a specific commodity in the world market through a specialised ETF. Their value fluctuates according to current market supply and demand, as well as views on their future prospects. You can invest in a range of commodity funds which focus mainly on those companies involved in energy, metals & mining and paper & forestry products.
Potential benefits:
- One of the few asset classes that can benefit from rising inflation
- Can help diversify a portfolio as commodity performance will often move in the opposite direction to equities in times of volatility
Things to consider:
- High risk asset class
- As material goods, commodities do not provide an income
- Difficult to predict in the short term
- The value of investments and the income from them can go down as well as up, so you may get back less than you invest.
Property funds often invest in commercial property rather than the residential market but you should still consider your house and any buy-to-let properties you own as part of your investment portfolio. Property funds benefit from the ability to invest in large commercial projects like shopping centres and retail parks. Fund managers can commit more capital to these properties and deal with fewer landlords than investing in residential schemes, as a result. Property funds also allow investors to invest smaller amounts than would be necessary to buy a physical asset.
Potential benefits:
- You can invest smaller amounts in a fund than would be required to buy a physical property.
- With daily dealing it is often easier to buy and sell a fund than a property.
- You can access the commercial property market in a fund, an opportunity not available to most personal investors buying directly into physical property.
- In a fund your money is spread over different properties and sometimes different countries, rather than one physical asset.
- Funds take away the responsibility of maintaining a property. You don't have to handle property deals and maintenance.
Things to consider:
- In times of market volatility, property funds may suspend trading so they can sell assets to meet redemption demand.
- Property prices may fall.
- Changes in currency exchange rates may affect the value of overseas investment.
- The value of investments and the income from them can go down as well as up, so you may get back less than you invest.
Carrying the lowest investment risk of the five assets, cash can be a useful asset to hold within a portfolio for a number of reasons. First, its inherently low investment risk provides good diversification to riskier assets. Second, holding cash allows you to take advantage of market dips, investing at the low point. Third, easily accessible savings held in cash can cover sudden unforeseen circumstances, without having to sell better performing assets.
Potential benefits:
- Carrying a low level of risk, cash offers good diversification opportunities when twinned with riskier assets
- Quick and easy access to your money
Things to consider:
- Inflation can reduce your money's real value
Important information - investing over 5+ years can help you build long-term savings. But invested money can fall in value too so you may get back less than you put in.
What next?
Find a diversified fund with Navigator
The Fidelity Select 50 Balanced Fund
Managing investments in uncertain times
Important information - Navigator and the Fidelity Select 50 Balanced Fund are not personal recommendations for specific investments. You must ensure that any fund you choose is suitable for your individual circumstances and remains so over time. Seek advice if you're unsure.
