Are you a financial risk taker? Assessing financial risk via shares, bonds, unit trusts and derivatives

So when it comes to investing, what is an acceptable level of risk?  Well, of course, it’s up to each of us to determine the level of risk we’re prepared to tolerate. You may be somebody who would happily contemplate descending a snow-capped mountain sat on a tea-tray. This outlook on life might translate into you feeling compelled to behave as the Indiana Jones of the investment circuit. Equally, if you wouldn’t dream of getting on a bicycle without sporting at least two sets of cycle clips, your devil-may-care bypass might point you towards a less racy investment strategy.

When it comes to investing, it’s vital to know what your personal level of risk tolerance is. For starters, let’s be clear what some of the primary investment vehicles are:

SHARES

When you buy shares, you are buying a small part of a company. As a part-owner, you are entitled to a portion of the profits that the company achieves. These are typically paid out in the form of an annual dividend. In a perfect world, as the value of a company increases over a period of time, the value of the shares you own also increase. However, you would do well to remember that time-honoured line about how the value of shares can go down as well as up. Also, a dividend payment is not guaranteed.

BONDS

Although the word might conjure up images of 007 and glamorous women wandering around nuclear plants in bikinis, a bond is really a very prosaic investment vehicle. When you buy bond, what you get is in effect an IOU for the amount you invest from a company or a government which they promise to let you have back on a fixed date (called the maturity date). On top of that, the bond issuer also promises to pay you a fixed amount of interest at regular intervals. Bonds issued by governments are called gilts. As governments can always raise taxes if they’re short of a bob or two, gilts are regarded as a pretty safe investment.

UNIT TRUSTS

A unit trust is typically a managed portfolio of shares and bonds. The word ‘managed’ is significant – somebody else is making the day-to-day decisions about which shares and bonds are bought and sold. When you put money into a unit trust, you are buying a small portion of that overall portfolio. If the value of the portfolio increases (share prices rise, interest or dividend payments are made, etc.), then you share in the spoils. Equally a decline in the value of the portfolio reduces the value of your investment.

DERIVATIVES

In essence, derivatives are high-risk financial instruments that can be traded on various markets. They are called derivatives because they are ‘derived’ from some real, underlying item of value (such as a stock, bond, currency or commodity). They are risky because they are time-fused and can expire worthless. The rapid growth in derivatives trading has played a major part in the growing volatility of the global financial system.

BUILDING SOCIETY SAVINGS ACCOUNT

You hand over your money and the building society periodically adds small amounts of interest. Dull but safe as houses.

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