Money: How far will you go?

`Risky' investment may be all in the mind, writes Edmund Tirbutt

How much risk are you happy to take with your savings? And how do you define risk anyway? You may think you make rational choices about money but in reality your upbringing may have a lot more influence than you admit.

Psychological research suggests our background and the way we are brought up has a profound influence on our lifelong attitudes to money. Those from well-off homes tend to be spendthrift even when money is short. Those from poorer backgrounds can still feel anxiety relating to their childhoods even when they don't have to worry about money.

Doctor Dorothy Rowe, a psychologist and author of The Real Meaning Of Money (Harper Collins, pounds 7.99), says: "People like me who come from a family where money is short still see it in terms of something that can disappear in adult life. When I'm short I go by bus, but lots of people from different backgrounds seem quite happy to chalk up debts on credit cards."

She also emphasises how financial planning can be complicated by contrasting attitudes to risk within relationships. Dr Rowe's research has found that most partnerships consist of an introvert and an extrovert who are drawn together because their attitudes complement one another. And that includes how they handle their finances.

"The extrovert sees security largely in terms of relationships with other people whereas the introvert sees it in terms of having some control over the future and tends to be more prone towards trying to make successful long-term investments."

If you are doing your own financial planning, be aware of your prejudices. A good independent financial adviser (IFA) will also get clients to talk about their attitudes to risk before making any recommendations about financial planning.

Mark Taplin, a partner at IFAs MacDonald Taplin in Leamington Spa, says: "Advisers can only act on what you tell them, so make sure you let them know what you want. Talk about your fears, feelings and aspirations. We've got to try to get into the client's head, and the more doors they leave open the better."

You face two main risks when you hand over your money to someone else to manage. One is the danger of losing your capital, so you get back less than you put in. This is relatively easy to understand even if you are unsure how to guard against it.

The other type of risk, which is not so easily understood, is that of losing value for money in the long term by failing to ensure that investments keep pace with inflation. Building societies are always keen to point out that no one has ever lost a penny in one of their accounts. But these accounts arguably represent one of the riskiest forms of investment because they have never kept pace with inflation over the long run. The value of your savings is eroded over time.

Before you think about risk, take your age into account. Even if you are a cautious person in your 20s, there is little point in investing all your pension contributions in a low-risk fund. In the very long term, shares are a safer bet. If you can't stomach that, at least go for a halfway house between cash and shares, such as a life insurer's managed or with- profit fund.

A growing number of people also challenge the received wisdom that you should switch to lower-risk funds as you near retirement. We need to generate much larger sums of money to see us through a retirement that can last 30 or 40 years. So get used to taking a chance.

Be realistic about the returns from your money. Research suggests most people expect their own investments to perform better than average. For example, "A Portrait of the Individual Investor", by Werner De Bondt, published in the European Economic Review 42 (1998 Elsevier Science), details a study of 45 individual American investors who each managed an equity portfolio. They agreed to make weekly forecasts of the Dow Jones Industrial Average and the share prices of one of their main equity holdings. The study found little difference between the actual and predicted performances of the Dow Jones. But when it came to their own shares, investors were significantly over-optimistic.

One of the consequences of cross-border investment is that the behaviour of different stock markets becomes interlinked. Over half the movement in the UK market can currently be explained by a movement in the German market, and vice versa. During the 1970s only a quarter of each market's movement could be explained this way.

The change means that those investing in both markets get far less chance to spread their risk than they used to. As the global economy becomes more closely linked, we'll all have to cope with extra risk caused by factors outside our control.

n IFA Promotion can provide details of local IFAs in your area. Tel: 0117-971 1177.

THE PREMIER RISK TABLES

Risk Grade 1

Bank and building society deposits

Cash and fixed-interest unit trusts

Short- and medium-dated gilts

Property unit trusts

Risk Grade 2

Managed life funds

Long-dated gilts

Managed pension funds

Fund of funds unit trusts

Risk Grade 3

UK equity life funds

International equity inc unit trusts

Diversified unit trust portfolios

UK equity and bond unit trusts

Risk Grade 4

UK equity & international pension funds

European unit trusts

Venture capital investment trusts

International equity growth unit trusts

UK equity including unit trusts

Risk Grade 5

UK growth and income unit trusts

UK equity growth unit trusts

UK smaller companies unit trusts

Diversified UK equity portfolios

Risk Grade 6

UK capital growth investment trusts

Medium cap equity portfolios

North American unit trusts

UK general investment trusts

Risk Grade 7

Smaller companies investment trusts

Far East (including Japan) unit trusts

European general investment trusts

North American investment trusts

Risk Grade 8

UK smaller companies inv trusts

Commodity and energy unit trusts

Japan unit trusts

Far East (including Japan) inv trusts

Risk Grade 9

High income investment trusts

Emerging markets investment trusts

Japanese investment trusts

Property investment trusts

Risk Grade 10

Far East investment trusts

Investment trust warrants

Source: Premier Fund Managers