Inflation risk

When considering whether an investment will achieve your objectives, you should take the rise in the cost of living into account.

Inflation measures the rise in price of a basket of basic goods and services. These make up the Retail Price Index (RPI). Recently inflation has been low (below 3%). But even if inflation remains at this level, prices will nearly double over the next 20 years or so.

Some high interest deposit accounts currently beat inflation, as measured by the RPI, before tax. However, this does not take into account several ‘cost of living’ factors that may be important to you. These include the rising cost of housing, the cost of a decent pension and the desire to achieve a better standard of living.

You may wish to look beyond inflation when planning for the future, even if your primary aim is simply to maintain your current standard of living.

Investment risk

You should aim to get the highest possible return for the level of risk you find acceptable. Or if you require a particular return, you should look for the investment that delivers this with the least risk.

When it comes to the risk that you won’t get back the money you originally invested, some investments, such as cash deposits and government bonds, are very safe: there is very little risk that you will lose money.

Using the same narrow definition of risk, shares are more risky. This explains why many people choose to put their money into more conservative investments.

But, if you consider the risk that your investment won’t give you the return you need to maintain or improve your standard of living, the roles are reversed. Cash and government bonds tend to produce a significantly lower return over the long term than shares.

Widely diversified investment

By selecting a broad spread of investments you reduce the risks associated with putting all of your eggs in one basket.

Spreading your investment between different assets, markets and investment managers is known as diversification.

To achieve the full benefits of diversification, you need a very broad spread of investments. An investment of 20 or so shares, for example, still leaves you significantly exposed to the risk of sharp movements in the price of individual shares.

There is also a real risk that you may suffer a significant permanent loss in a small portfolio, if one of the companies you have invested in suffers major difficulties or goes out of business.

A typical Inscape portfolio contains over 750 individual investments.

The advantages of pooled funds

A pooled investment fund combines (pools) your money with other investors’ in a professionally managed portfolio. This gives you a better spread of investments than you would normally get investing on your own.

You also benefit from low administration and transaction costs. The cost of each purchase or sale of individual investments within a pooled fund is shared by all the investors.

We construct portfolios within a pooled fund structure. This gives you a very broad spread of investments covering different asset classes and markets around the world.

Inscape’s pooled fund has an Open Ended Investment Company (OEIC) structure. OEICs are similar to unit trusts, the most commonly found type of collective investment in the UK.

Managing risk over time

Volatility measures the amount an investment goes up or down over a given period. The greater the volatility of an investment, the more risky it is.

Investing for a long period of time can help to smooth out the effect of swings in the value of an investment. As time goes by the investment will continue to rise and fall, but the chance that periods of strong performance will at the very least cushion you against the effect of dips, gets significantly better. In effect, this makes the investment less risky.