Investment Risk: Making Informed Decisions Amid Uncertainty
Investing always involves uncertainty, but understanding how risk really works can make the difference between reacting emotionally and making confident, long-term decisions. Rather than something to be avoided at all costs, risk is a fundamental part of how wealth is built — and learning how to manage it effectively is key to achieving meaningful financial goals over time.
When people hear the word “risk” in relation to investing, their instinctive reaction is often the fear of losing money. That response is entirely understandable. Nobody likes the idea of their hard-earned savings falling in value. However, investment risk is not simply about loss. It is also the very reason investors are able to grow their wealth over time.
To make sound investment decisions, it is important to consider risk from both perspectives: the potential downside and the potential upside.
When these two elements are viewed together — rather than focusing solely on what could go wrong — investing becomes a more balanced and empowering process, one that supports long-term financial objectives rather than short-term emotion.
What is investment risk?
Investment risk refers to the uncertainty surrounding future returns.
That uncertainty can result in negative outcomes, such as temporary falls in asset values or returns that are lower than expected. Equally, it creates opportunities for positive outcomes — including the potential to achieve returns that exceed cash and inflation over the long term, allowing wealth to grow more effectively.
Without risk, investments would not offer meaningful growth in either income or capital. If returns were guaranteed, they would remain low, much like the long-term interest available on cash savings.
Risk is what makes it possible to:
- benefit from long-term compounding
- protect purchasing power against inflation
- grow wealth faster than holding cash alone
- achieve long-term goals such as retirement or purchasing property
As investors, we also have to recognise the human element. Managing risk is not only about numbers and projections, but also about understanding how we feel about uncertainty, how much volatility we can tolerate, and what level of return we need to reach our goals.
There are three key questions worth considering.
- What is your attitude to risk?
Your attitude to risk is personal. It reflects how comfortable you are with fluctuations in the value of your investments and how you might react emotionally during periods of market movement.
This is sometimes described as risk tolerance — in other words, how much uncertainty you can live with without it influencing poor decision-making.
If you would like to take an Attitude to Risk Questionnaire, this can be completed on our website at: www.pwa-intl.com/atr - What level of return (and risk) do you require?
Once you have defined your goals, you may have an idea of the return you need to achieve over the long term. In some cases, the level of risk required to meet those goals may be higher or lower than your natural comfort level.
This is where the risk-return trade-off comes into play. Generally, lower-risk investments tend to offer lower potential returns, while higher-risk investments offer higher potential returns but with greater short-term volatility along the way.
Lower risk typically means lower potential return.
Moderate risk tends to offer moderate potential return.
Higher risk brings higher potential return, but a less predictable journey.
- What types of investment risk should you understand?
- Capital risk
This is the most familiar form of risk — the possibility that an investment falls in value. It matters, and it should not be ignored, but it is only one part of the overall picture. - Inflation risk
Holding money in cash may feel safe, but over time inflation can erode its purchasing power. Your balance may stay the same numerically, but what it can buy in the future may be significantly reduced. This is often an overlooked risk. - Opportunity risk
By choosing very low-return options, you may miss out on opportunities for higher growth elsewhere. Over long periods, this can have a substantial impact and may reduce the likelihood of achieving goals such as a desired retirement income. - Volatility risk
Some investments fluctuate more than others. Volatility can feel uncomfortable, but it does not necessarily mean a permanent loss. In many cases, it reflects short-term market movements rather than long-term value.
Time horizon also plays a role. For example, younger investors with decades until retirement are often better placed to tolerate short-term fluctuations, as they are not relying on immediate access to their invested capital.
Managing investment risk
The aim is not to eliminate risk entirely — in practice, this is rarely possible. Even cash is exposed to inflation risk over the long term. Instead, the objective is to understand risk, manage it appropriately, and align it with both your goals and your behaviour as an investor.
This means balancing how much risk you are comfortable with against the level of risk you may need to take in order to achieve your long-term objectives.
If you are considering investing but are unsure where to start, having a clear framework for managing risk can provide a far more confident foundation for decision-making.
Will is an Independent Financial Adviser with over a decade of experience helping expats make the most of their international status.