Types of risk
To get the most out of your savings ideally you want to beat inflation with higher returns than you might get from a normal savings account. Inflation is a general rise in prices across a wide range of goods and services. You may want to do this at a level of risk you're comfortable with.
Generally, the more risk you take, the greater the potential rewards, although this is not guaranteed. But everyone feels differently about risk, so here’s an overview of the main points to consider:
1. Interest rate risk
If you save your money in a fixed rate account you might earn less interest than the market average if savings rates rise. On the other hand, if market rates fall, your fixed rate might be higher than others that are offered.
2. Inflation risk
It's likely that you know how inflation affects your money. Imagine if you put money in an account earning 2% interest per year, but inflation was at 3% over the same time. Your original investment increased in value but its buying power went down by 1%.
3. Capital risk
As a general rule, if you aim for higher returns you must be willing to take a higher risk. This is because where higher returns can potentially be earned there is also a greater chance of a drop in the value of your investment.
You need to find a balance between the risk to your capital that you can cope with and the returns you need to reach your investment goals.
4. Market risk
This is the risk of a fall in the stock market of the country where your money is invested. When an index such as the FTSE 100 falls, most shares usually fall too. Some by more than the average, some by less, but a few will buck the overall trend.
You might think about investing gradually, such as on a monthly basis, to smooth out big changes in the price you pay. Or if you’re investing over a period of at least five years there may be time to recover from any market losses. It’s important to remember that you may not get back the original amount you invested if investment markets fall.
5. Performance risk
Similar funds may vary in how they perform due to differences between assets selected by each fund. Funds aiming for high performance may vary more than those with a more cautious approach to investing. How well a fund performs in the future is a question that can be estimated, but not known with complete certainty.