Why being too risk-averse when investing can affect your long-term plans

In recent months, the coronavirus pandemic has affected the UK in a variety of ways. It has taken more than 160,000 lives and the national lockdowns that the government imposed to slow the spread have had a significant impact on the economy.

With this in mind, it shouldn’t be surprising that it has also affected many people psychologically. After so many months of worrying about the wellbeing of loved ones, a lot of people have become less optimistic about the future.

According to a study by Abrdn, published by FT Adviser, one-third of people stated that they are now more risk-averse than they were prior to the first national lockdown in early 2020. While this may be understandable, this lower tolerance for risk could make it harder for you to reach your financial goals.

If you’re investing your wealth and want to avoid this prospect, read on to find out why being too risk-averse could be holding you back.

Around one-third of people under the age of 40 state that they have a low risk tolerance

As you may know, when you pay into a defined contribution pension, your money is typically then invested on your behalf so it can grow over time. This includes your own contributions, the contributions made by your employer, and any government tax relief.

With almost all investments there is an element of risk as the value of an asset can both rise and fall. However, most pension providers will typically let you choose just how much risk you’re willing to expose your wealth to.

For many people, a low-risk approach can seem like common sense. According to interactive investor’s 2021 Great British Retirement Survey, around one-third of people under the age of 40 stated that they had a low tolerance for risk.

However, when it comes to investing, this isn’t always the best approach. In fact, being too cautious can sometimes hurt your long-term prospects.

Your investing strategy is largely dependent on what your life goals are

Typically, the greater the risk of an investment, the greater its potential for reward. This is why taking a cautious approach isn’t always the best strategy. While you may minimise your chance of losing money, you’re also reducing the potential growth that your wealth could achieve.

To be able to properly assess how much risk you should expose your investments to, there are two main things to consider: your age and your goals.

One of the main benefits of investing your wealth while you’re young is that you typically have a longer time horizon. Essentially, when you invest for the long term, you have a longer period for financial volatility to smooth out. This means that you can typically afford to take more risks.

The second factor that can influence your investing strategy is how ambitious your long-term goals are. As you might imagine, the larger your goals, the more money you will need to achieve them, so the more risk you may need to expose your wealth to.

For example, if you plan to retire early, your investing strategy may need to reflect this. Not only will you need to have more funds, since you’ll need your wealth to support you for longer, but you’ll also have less time to make contributions.

This means you may need to expose your pension wealth to a greater degree of risk, in order to generate stronger returns.

Rising inflation may mean your investments need to work harder

Another potential problem with low-risk investing is that your returns may be diminished by the rate of inflation, which has been rising in recent months.

According to figures from the Office for National Statistics (ONS), the Consumer Price Index including housing costs rose by 3.8% in the year to October 2021.

The reason why this is worrying is that inflation erodes the true value of your money, meaning that, over time, it is worth less and less. In the long term, your cash could have significantly less buying power.

A useful tool for understanding just how much impact inflation can have on your wealth is the Bank of England’s inflation calculator, which shows the change in prices over time.

According to this, if you wanted to buy £10,000 worth of goods and services in 1990, you would have needed £10,000. Today, after 30 years with an average inflation rate of 2.9% in that period, they would cost you £23,244.

If your investments are not exposed to enough risk, your returns may only be barely above the rate of inflation. This means that they are growing very slowly in real terms.

Working with a financial planner can help you to find the right level of risk for you

If you’re concerned that you won’t have enough investment wealth to support your long-term plans, speaking to your financial planner can help to give you greater peace of mind.

They can help you to properly assess your financial situation, goals, and current level of risk tolerance to see if it’s right for you. If your long-term plans change, your investing strategies may need to be altered too.

For example, if you want to bring your retirement forward, they may recommend that you raise your risk tolerance in the hope of seeing stronger returns. Conversely, if you opted to delay it, you may want to lower your risk tolerance, so you aren’t exposed to more risk than is necessary.

Whatever your long-term plans are, speaking to a professional can help to give you more peace of mind. You’ll know that you are on track to meet your goals while not exposing your money to more risk than is necessary.

Get in touch

If you want to know more about whether your current risk tolerance when investing is right for you, we can help. Please email enquiries@metiswealth.co.uk or call 0345 450 5670.

Please note:

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

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