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What do we mean by risk?

What do we mean by risk? If you’ve ever seen a billboard advertisement for financial services, you’re probably familiar with standard phrases such as “The value of investments can fall as well as rise” and “Past performance is not a guide to future performance.” And yet the ubiquity of these warnings can have the opposite effect of what they’re supposed to convey; the words are so familiar that the important caveats risk being ignored, like the voice at the end of a radio promotion gabbling that “terms and conditions apply”.

At Nutmeg, we want you to be very clear about what we mean by “risk” in the context of saving and investing.

The value of your investments can go up as well as down

If your savings are in cash with a reputable bank or building society, they are normally guaranteed by the government up to the value of £85,000 per institution. This means that if the bank goes bust, you will get back up to £85,000 of your money. And if the bank remains solvent, there is no danger that you might get back less than you put in.

When it comes to investing in things that are not cash, on the other hand, nothing is guaranteed. Share prices fall as well as rise. Companies can – and do – run into financial difficulty. Even governments sometimes struggle to repay their loans. All this can make investing a risky business.

So why do people invest? The short answer is that equities have historically delivered much higher returns than cash over the long term. Similarly, the yields on bonds tend to be higher than those available for cash deposits. This is because investors demand what is called a “risk premium” for investing. In other words, if you put your money into something that you know could go down, you want more in return than if you put the cash in the bank.

It is also worth pointing out that, although some ways of looking after your money are obviously safer than others, there are never any cast-iron guarantees. Inflation erodes the real value of your cash savings when they’re earning small amounts of interest in the bank.

Property can also be subject to large fluctuations in value – and as with investing, you may get back less than you put in.

The bottom line, therefore, is that no single asset class can be relied upon to produce safe, reliable and consistent returns. At Nutmeg, we believe that a diversified investment portfolio – with an appropriate proportion of cash, equities, bonds, property, commodities and alternative asset classes for your goals and risk tolerance – is a better way of maintaining and building wealth over the long term.

Past performance is not a guide to future performance

If only it were, investing would be very easy! Unfortunately, a company which performs well one decade might find itself squeezed out by leaner competitors the next. Sectors go in and out of fashion (think of the dot com bubble in the late 1990s). So do different asset classes, countries, even continents. While we do, of course, analyse past performance – and learn as much from it as we can – we never rely on it.

Investing is not a short-term option

The prevailing wisdom, with which we at Nutmeg agree, is that people should only invest with the long-term in mind. This will give your investments more time to ride out any shorter-term fluctuations in the markets.

Nutmeg may not be for everyone

At Nutmeg we believe it’s really important that you understand what we do and what we don’t do, so that you can make an informed decision about whether or not to invest with us. You can read more about this in our FAQ or get in touch. If you are still unsure if investing is right for you, please seek independent financial advice.

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