How your risk profile shapes your investment choices

There are no risk-free choices when it comes to personal wealth.

Regardless of whether you’re investing your savings or leaving them as cash, there is a risk associated with every decision. Investments can go up and down in value and you may get back less than the sum originally invested. Cash is at the mercy of inflation, so its value diminishes in real terms as the cost of living rises. Wherever you look, there is an element of risk.

Even so, some investments can be considered higher risk than others. For example, shares in a biotechnology company trading on the UK’s more lightly regulated AIM market are relatively high risk. But an inflation-protected bond issued by the UK government is a relatively low-risk investment.

At Schroders Personal Wealth (SPW), one of our key principles is diversification, of not putting all your eggs in one investment basket. Different types of investment respond differently to different economic and market conditions. By investing in a selection, or portfolio, of different assets, you could reduce the chances of your investments as a whole falling prey to particular economic or market factors.

A portfolio with most of its holdings in equities (shares) can be considered higher risk than a portfolio with most of its holdings in government bonds and lower risk (investment grade) corporate bonds. At SPW, we have nine Personal Discretionary Portfolio Service (PDPS) portfolios, each with a particular risk level. In December 2023, equities made up 57 percent of the holdings in our higher risk Progressive portfolio. In contrast, government bonds and investment grade corporate bonds made up 58 percent of the holdings in our lower risk Cautious portfolio.

If you decide to use our wealth management services, your adviser may well recommend you invest in one of SPW’s PDPS portfolios. But which one might be recommended to you would depend on your risk profile.

What is a risk profile?

Risk profiling is a crucial tool for financial advisers. It allows them to accurately assess your specific attitude to risk and, in turn, ensure your money is invested accordingly. This is a deeply personal process that considers your unique situation and your ability to withstand periods of financial uncertainty and, in the worst case, a significant loss.

While there is no foolproof approach to investing, this process aims to ensure your investments directly align to your financial requirements.

So how does this work and how do we ensure we profile you correctly?

Risk profiling is a multi-step process in which you engage directly with your adviser to establish your financial preferences and circumstances, including your capacity and tolerance for loss. Capacity for loss concerns the level of risk you can take without jeopardising your financial stability or life goals. Your adviser also wants to make sure you are clear on how and why your money is being invested where it is, and what you can expect from your investments.

For example, not every holding in a diversified investment portfolio is held for its potential to produce high returns. Some investments may be held for their ability to hold up in economic downturn, while others may be included because they may be able to offer smoother returns during periods of market turbulence. Having clarity about these underlying investments could give you a degree of comfort and greater peace of mind, particularly during turbulent periods.

Risk tolerances

Various elements shape your attitude to risk. Age is an important factor: it will often determine your rationale for investing and how long investments might be held for.

Younger people are typically willing to take on greater investment risk than older people, although this is not always the case. But, in general, we save for retirement throughout our adult lives and our risk tolerance lowers as we approach the age when we’ll need to draw on our retirement savings.

Assessing a risk profile is a very personal process. We all have different goals and varying personal circumstances. Ultimately, the aim of building a risk profile is to understand someone’s life goals, their desired financial outcome, and how much financial risk they are willing and able to take.

At SPW, one of our key financial planning principles is to have regular reviews with a financial adviser, to help keep you on course to meet your goals.

We appreciate that life can change quickly and dramatically, and these changes might affect your financial situation. You may get married or have children, or perhaps a loved one may fall ill and require ongoing medical attention. Even the loss of a job, however temporary, may affect your financial outlook. By engaging in regular reviews, we can ensure that as your circumstances change, your risk profile is adjusted accordingly.