Investing always involves some level of risk, you know this.

Long-term success comes from understanding and managing that risk rather than trying to avoid it entirely.

Whether you are building wealth, planning for retirement, or preserving capital, assessing risk appropriately is the cornerstone of any sound investment strategy.

But, how do you do it? How do you assess risk in a way that enables you to invest appropriately to achieve your goals? You are in the right place to found out! Read on below.

Know the key types of risk 

To start making progress, you first need to understand the key types of investment risk. It comes in many forms, and different types of risk affect different parts of your portfolio.

Remember, no investment is risk-free.

Recognising where these risks lie is the first step in managing them effectively. 

You can read more about risk on our dedicated page: Investing and Risk.

Market (systematic) risk  

Refers to the potential for broad economic factors to affect the value of your investments, such as inflation, interest rates, or geopolitical events. These are typically areas that you have no control over (with the exception being if you are in a government or policy decision making position).

Company-specific (unsystematic) risk  

This arises when individual shares or bonds underperform due to issues specific to that organisation.

Currency risk 

If you hold investments in foreign currencies, changes in exchange rates can impact the value of your returns. Even if the underlying asset performs well, currency movements can either amplify gains or reduce them.

Liquidity risk 

This is the risk of not being able to sell an investment quickly without significantly affecting its price. Assets that are less liquid may be harder to convert into cash when needed, particularly in volatile markets. The most popular example here being a property sale that could take months or years.

Legislative risk 

Changes in laws, regulations, or tax rules can impact investments. For example, a change in capital gains tax rates or pension legislation could alter the attractiveness or outcome of a particular strategy.

A well-diversified approach can help manage these risks more effectively over time.

Understand your risk tolerance and capacity for loss

Risk tolerance is your emotional comfort with the ups and downs of investing (the ‘investment rollercoaster’). It reflects how well you cope with seeing the value of your investments fluctuate (‘volatility’).

Some investors are comfortable with high levels of volatility if it means the potential for long-term growth, while others prefer more stable journeys even if the overall returns might be lower.

Capacity for loss, on the other hand, is your financial ability to absorb a downturn without it affecting your existing lifestyle. It is not about how you feel, but about for what your situation allows.

For example, how much value can your investments lose before you can no longer continue your lifestyle in its current state? Can you lose 10% and live normally? 20%? 30%? Perhaps you are you able to sell other assets to make up for the shortfall?

In simple terms, the larger loss you are able to absorb, the higher your capacity for loss (and the reverse is also true).

This means that you may not be in a position to take on significant investment risk, even if you feel emotionally confident doing so.

Risk tolerance and capacity for loss should be considered in tandem. Simply being comfortable investing in 100% equity does not necessarily mean it is appropriate if your financial circumstances cannot support the potential volatility.

Your portfolio should reflect both your mindset and your real-world limitations.

Align risk with your goals and time horizon

Investments are best tailored to your objectives. If your goal is to preserve capital for a short-term purchase, a high-growth equity strategy is unlikely to be appropriate.

Conversely, if your goal is to grow wealth over 15 to 20-years, holding too much in low-risk, low-return assets (cash for example) can be a risk in itself.

Matching the level of investment risk to your time horizon is a key part of maintaining discipline through market cycles. 

Diversify across asset classes and sectors 

Diversification is one of the most effective ways to manage investment risk. By spreading your assets across equities, bonds, property, and alternatives (further diversifying across regions and sectors), you can reduce the impact of poor performance in any single area.

Naturally, this is with the hope that the better performing assets increase by more than the poor performing assets decrease.

A well-diversified portfolio does not eliminate risk, but it does reduce the likelihood of significant losses from any one event or trend.  If the economy is crashing and every asset class is falling, you will make losses.

Review regularly and adjust when needed 

Now you have a basic understanding of the key factors at play when managing risk, you should know that it is not a “set and forget” exercise. Your financial situation, goals, and attitude towards risk are likely to change over time.

Reviewing your investment strategy periodically helps to keep your risk level consistent and remain aligned with your evolving needs, preferences and market conditions.

Luckily, such reviews are part and parcel of our service at Patterson Mills. You do not have to do it alone, get in touch with us today by e-mail to contactus@pattersonmills.ch or call +41 (0) 21 801 36 84 and we shall be pleased to assist you.