Not every investor is looking for excitement

Choose funds that suit your approach to risk, advises Sam Dunn
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The Independent Online

Presented with the hypothetical choice between a guaranteed loss of £30,000 or an 80 per cent chance of losing £40,000, most of us would plump for the latter.

Presented with the hypothetical choice between a guaranteed loss of £30,000 or an 80 per cent chance of losing £40,000, most of us would plump for the latter.

But while it's easy to be gung-ho when we aren't gambling with our own cash, we are much more cautious when we invest our hard-earned income. This is the conclusion of research cited in Fear, Greed and Panic: The Psychology of the Stock Market by David Cohen (Wiley, £16.99).

It is not surprising that so few of us have much appetite for risk. Years of poor returns, shaky stock markets and mis-selling scandals have left savers reluctant to invest, and the financial services industry is expecting sales of individual savings accounts (ISAs) for the 2003-04 financial year to remain flat.

However, the FTSE 100 ended 2003 up on the beginning of the year - the first time this has happened in four years - and many advisers are cautiously optimistic that investors will soon start to return to shares.

But you shouldn't jump back into equities without first assessing how exposed your portfolio may already be and how much risk you can actually afford to take on.

"Everybody has their own individual risk profile, and you must try to match this with appropriate investments - to buy what is right for you," advises Darius McDermott, managing director of independent financial adviser (IFA) Chelsea Financial Services. "Don't buy a high-risk fund, for example, just because a friend has invested in it and it's doing really well so far."

Although IFAs are paid to help you work out how much risk you are willing to take with your investments, it helps to develop a strong sense of what you want before you consult one.

It is sensible to invest only what you can afford to lose. You should also take into account your age and what you hope to do with the money in the long term, recommends Meera Patel, senior analyst at IFA Hargreaves Lansdown.

"The younger you are, the more adventurous you can be, as you have a longer period of time for your money to grow and you can put up with volatility in the markets," says Ms Patel. "Later on, you might need cash for retirement and you won't want a huge amount of fluctuation in your portfolio."

Millions of us use an ISA to invest tax free in the stock market, but as we often buy popular funds on the back of advertising campaigns from fund management houses, our portfolios can have an unsuitable spread of investments. In many cases, they can carry much more risk than we would actually like.

To work out how risky your portfolio is, start by looking at where your ISAs are invested - usually bonds, equities or cash - and compare this with a typical spread of investments held by a cautious investor. Hargreaves Lansdown cites an example of a risk-averse portfolio as having 60 per cent invested in bonds, 35 per cent in shares and the rest in cash.

If you are prepared to take on a higher degree of risk, you could invest all your money in the world's stock markets. At least half of a typical portfolio of this sort might be invested in the UK, 20 per cent in the US and 15 per cent in continental Europe, with the rest spread across Japan, China and emerging market economies.

Cautious investors should avoid specialist funds such as those investing in biotech or technology stocks, says Ms Patel. Remember, too, that the nature of a particular investment can change. Bonds and funds investing in bonds are a case in point, she adds, and these should be closely monitored: "People regard them as a low-risk investment but that doesn't mean that [some safer] investment bonds won't get downgraded or go into default. Buying bonds or funds now is more risky than, say, two or three years ago."

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