What level of risk are you comfortable with?

Earlier in this guide, we have referred to your attitude to risk being cautious or low or medium, and it would be useful if we expanded on what we mean by these terms, as you need to be sure what level of risk you wish to adopt through retirement.

Have you ever tried to rationalise the level of risk with which you are comfortable? To help you get a feel for the degree of risk with which you are comfortable, definitions are set out below, with indications of how much the fund values may vary. These are extracted from our TopFunds Guide.

LOWER RISK
You are prepared to accept some capital volatility to get a better return than on deposit, but do not want the day to day risk of a stockmarket investment. This lower risk sector would include mainstream corporate bond and property funds, and also protected funds.

The reward: Over the last 10 years, the total return from a typical, good, corporate bond fund was 95%, with net income re-invested, whereas, on deposit, the return would have been 69%.

The risk: Looking at a typical good lower yielding corporate bond fund, based on the last three years, our statistical analysis suggests that, in most months, you should not see a fall in the capital value exceeding 1.1%.

Looking a little beyond 10 years, the worst period was 1994/5. A typical lower yielding bond fund would have lost about 9% in 1994/5, and if you had been drawing income the fall in the capital value would have been more like 15%.

MEDIUM RISK
This is for those comfortable with stockmarket risk, meaning that you’ve probably lived through periods of extreme volatility before, and are comfortable taking a long view (at least 5 years). This would cover mainstream UK and European stockmarket funds.

The reward: Over the last 10 years, the total return from a typical, good, UK stockmarket fund was 248% with net dividends re-invested, whereas, on deposit, the return would have been 69%.

The risk: Looking at a typical good fund in the UK All Company sector over the last three years, the statistical analysis suggests that in most months you should not experience a fall in the capital exceeding 4.5%.

Looking back over 10 years, we are still in the worst period, which began in early 2000. Despite a recovery in 2003, we are still below the highs of late 1999. A typical good UK stockmarket fund would have lost a bit more than 30% in this period though many have been down in excess of 40%. Prior to this period, the steepest loss for our “typical good” fund was 14% in 1994, and it took 18 months to recover.

HIGH RISK
We suggest this means that as well as your being attracted to some years of 100% growth (such as with technology in 1999), you must also accept occasional years of 50% losses, and be taking a 10 year view at least. This would include technology, Japan, and smaller companies, emerging markets.

Our experience is that high risk funds often do not provide the consistent year to year performance of something like a good mainstream UK stockmarket fund. Not only will you see the value 100% up and 50% down over relatively short periods, but for long periods (years) you may experience lacklustre performance, until the fund eventually explodes upwards.

The reward: Occasional years of 100-200% returns.

The risk: In the higher risk area we can consider a number of sectors to illustrate the risks. Looking at a typical Japan fund, based on the last three years, the statistical analysis suggests that in most months you should not see a fall exceeding 9%. With a technology fund the equivalent figure has been in excess of 22%.

Over the last 10 years, the worst period for a typical Japanese fund was the 44% loss to August 1999. And 80%-plus losses have been experienced by technology funds.

ACTION? Contact us
If the investment area is also one that you need to explore (we would certainly encourage a review in this area as you approach retirement), do get in touch with us now. In the first instance, we will send you through the latest copy of our acclaimed TopFunds Guide, which includes analysis on the current investment outlook and a model portfolio. Then, you can also let us know more about you and your requirements, and we can establish how we can help you.

Thanks for your e-mail news letter. Always a joy to recieve. Informative and thought provoking....
[read more]