The risk business - even doing nothing is dangerous

By Mark Fryer

It's a fair bet that when most of us think about the risk involved in an investment, we're weighing up the chances of the firm whose shares we buy going bust, or the bank collapsing.

But risk goes a lot further than that, and if you want your money to grow there's no way of avoiding it entirely. All you can do is be aware of the risks you are running and try to minimise them.

That first risk does exist - you can copy the experts and call it "classical risk" or "capital risk" if you want to impress people - but when investment experts use the R-word they may well be talking about something altogether different.

That something is volatility, or "market risk" or "portfolio risk" depending on which school you went to. In short, it's the danger that the value of some investments - shares being the obvious example - can go down as well as up.

So while it may be alarming to hear a particular type of investment being described as "risky", it may just mean it is likely to enjoy higher highs and suffer lower lows than some other investment.

Analysts devote a great deal of time to studying the past in order to work out the volatility of different types of investments, and can tell you the chance of losing money over any particular period - assuming the past is an accurate guide to the future.

From a practical viewpoint, anyone who puts money into something that is likely to be volatile has to be comfortable with that fact, and must be prepared to invest for the long term.

There's little point going into shares in emerging markets - a particularly volatile area - if you know you're going to want your money out in six months' time.

The existence of volatility is also an argument for diversifying - spreading your money across various types of investments, or different markets, in the hope that they don't all go up and down at the same time.

Your readiness to accept volatility is also likely to depend on how old you are - not just because the young tend to be less cautious than the old, but also because they have more time to recoup any fall in the value of their investments.

Income matters too - it's much less frightening to put some of your money into something risky if you're earning a lot of it.

There's no shortage of other risks to worry about too. One is inflationary risk - the danger you face even if you do nothing with your money, or especially if you do nothing with your money.

Simply, it's the danger that the amount your money earns won't keep pace with inflation, meaning that the purchasing power of your assets is shrinking. It's a danger that investors who had money in the bank during the inflationary 1980s will remember well.

It's one reason why even those investors whose main goal is to earn an income to live on are often advised to have at least part of their money in "growth" investments which stand a better chance of outpacing inflation.

Then there's selection risk - the danger that, even if you choose the right sector to invest in, you just may choose the wrong investment within that category. It's another argument for diversifying, so one failure is not devastating.

Don't forget timing risk either. It's the danger that, with the best strategy in the world, you just may choose the wrong time to execute it - putting money into the sharemarket the day before it crashes, for example.

Again, it's a good argument for taking the slow but steady approach and staying in for the long haul.

Credit risk is yet another one to worry about. It applies to fixed-interest investment and is the risk that the issuer may not be able to pay back your money. Look for a credit rating or, at very least, be aware that you don't get the highest interest rates without running the highest risks.

Finally, there's liquidity risk. That's the danger that when you want to sell your investment, there may be no one around willing to buy it.

With some investments - Government stock, for example, or shares in a big company - you should have no trouble finding a buyer, though you'll have to take whatever price the market decides.

If, on the other hand, you've invested in a highly-specialised property in an undesirable part of town, extracting your money may be a much more drawn-out process.