How much risk is too much risk when it comes to your money?

In investing, the general rule is that the more risk you take, the greater the potential rewards. But the stock market can go down as well as up, and the idea of losing money is never pleasant.

That’s why so many Brits put their money into cash savings rather than the stock market. According to latest figures from the Office for National Statistics, more than 8 million of the 12.4 million Isas opened in 2022-23 were cash accounts.

But to give your money the best chance of growing over the long-term, you’ll need to invest it – and that means taking a degree of risk. The question is: how much?

You’re already taking risk – but the wrong sort

It is easy to assume that leaving cash in the bank is completely safe, but this is a fallacy. As inflation pushes up the cost of living, the “real terms” value of cash – its purchasing power – is eroded away. If inflation is 4 per cent then something that costs £100 today, will cost £104 next year, so your £100 in the bank could no longer afford it.

The key is to make sure your money is growing at a faster rate than inflation so your wealth keeps pace with the rising cost of living. Research shows that investing in the stock market is the most reliable way to do this over the long-term.

According to the Barclays Equity Gilt Study, which looks at data going back to 1899, investing in equities has delivered annualised returns of 6.8 per cent over the past decade after factoring in inflation, while cash has lost 1 per cent a year. Over 50 years, the stock market has delivered annual returns of 8.1 per cent compared to just 0.6 per cent for cash.

Meanwhile, research by IG Group found that someone who had maxed out their Isa allowance every year since 1999 would have £275,659 today in real terms if they had put it in cash – but £410,051 if they had invested it in the FTSE 100.

“If you don’t take enough risk for long-term financial goals, such as retirement, you may end up with a much smaller pot,” says Craig Rickman from the wealth manager interactive investor.

Risk versus risky

Fear of losing money is a key reason so many savers are reluctant to invest.

But risk is different to “risky”. Many people associate the idea of “financial risk” with “gambling”, but this is not necessarily the case.

Risky is the chance of losing some or all of your money in the hope of big gains (think: putting it all on red at the casino). Risk, on the other hand, is the potential for ups and downs along the way, known as volatility. This is what we see on the stock market: it tends to rise over the long-term, with short-term dips along the way.

As long as you don’t need to access your money during a dip, you can ride this out in the hope of greater gains in the future.

Younger investors in particular are often told to take more risk because they have more time to wait out those ups and downs. Claire Exley, head of financial advice and guidance at Nutmeg, says: “What matters really is the value of your investment when you need the money, rather than the movements in value along the way.”

Investors need to weigh up how much risk they need to take to generate the returns they hope to achieve, while still being able to sleep at night during those market dips.

However, it is also important to pay attention to your gut instincts; some people are naturally more risk averse and won’t be comfortable with any volatility, regardless of what the data shows.

What to invest in

Diversification is key to a smooth investment journey, especially for those just starting out. This means spreading your money across different companies, countries and assets.

A broad global tracker fund, which invests in thousands of companies across the globe for a low cost, is a good place to start. To further spread your risk, you can add in different “asset classes” (types of investment), such as bonds, gold or property.

Many investing apps, such as Moneyfarm, Nutmeg, Dodl and Wealthify offer readymade portfolios that create an appropriate mix of investments, which is a good option if you don’t feel confident choosing your own.

Free risk questionnaires can help you determine your risk tolerance. These ask questions such as how long you plan to invest, whether you would describe yourself as a cautious person, and how you would feel about short-term fluctuations.

Nutmeg, an investing app, said the average risk level for investors aged 18 to 29 is seven out of 10. This portfolio has 71 per cent in equities, 26 per cent in bonds and 3 per cent in cash – it has returned 71 per cent over the past 10 years. That compares to 22.2 per cent for Nutmeg’s Level 3 portfolio and 120 per cent for Level 10.

Before you start investing, experts typically advise having three to six months’ of outgoings in an easy-access account in case of an emergency. Investing should be for a minimum of three to five years, so don’t invest money you might need to access.

Rickman says: “Ultimately, risk appetite is a personal thing. Some people are happy to stomach heavy falls in value for the potential to make more money, and others are more cautious, favouring security and certainty over big potential returns.”

When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.