4 reasons why it can be risky to be too risk-averse with your wealth

In recent months, the stress of the coronavirus pandemic has weighed heavily on people’s minds. Not only have we been worried about our own health and the wellbeing of our loved ones, but many Brits have also had to contend with greater social isolation.  

On top of this significant strain, the recent outbreak of war in Ukraine has also heightened many people’s anxieties. These events have had a major effect on the world around us and so it’s understandable that it has had a psychological impact on a large portion of the population. 

According to a study published in FTAdviser, around one-third of Brits stated that they are now more averse to risk than they were prior to the pandemic.  

In such troubled times, it’s easy to worry about the value of your portfolio. However, taking too few risks can actually be more dangerous for your long-term prospects than taking too many, so read on to find out four reasons why. 

1. Cash tends to grow more slowly  

If you’re too averse to risk, you may choose to hold a large portion of your wealth in cash, rather than investing it. While keeping some in an emergency fund can be useful, holding too much of it in this way can hurt your long-term prospects. 

Despite the Bank of England recently raising its base rate to 0.75%, interest rates on cash are still relatively low. This means that your wealth will grow very slowly if you hold a large portion of it in this way. 

Furthermore, rising inflation could erode the real value of your money. According to figures from the Office for National Statistics (ONS), the Consumer Price Index (CPI) rose to 6.2% in February 2022. 

However, according to data from Moneyfacts, as of 21 April, the highest interest rate for an easy-access saving account was just 0.8%. This means that money held in cash is losing its buying power over time. 

1. You could miss valuable opportunities 

Another issue with being too averse to risk is that you could progress towards your financial goals more slowly, due to missing out on valuable opportunities. 

For example, you may choose to prioritise “safer” investments, such as corporate bonds or gilts. While these might present a very low risk to you, they might not give you a very strong return. If your wealth grows too slowly, you may be forced to reassess your long-term plans, such as delaying your life goals.  

While lower-risk investments, such as bonds, can have a place within any well-balanced portfolio, if you rely on them too heavily, it can affect your financial plans. 

1. Rising inflation means that real returns are lower 

As we mentioned earlier, figures from the ONS show that the CPI rose to 5.5% in the year to January 2022. This is a problem as not only does inflation affect the wealth you hold in cash, but it can also affect your investments. 

Even if your investments are showing good growth, a high rate of inflation may mean that their real value isn’t increasing by as much as you might think. For example, if an investment rises in value by 5%, but at the same time there is inflation of 4.5%, then it has only grown in real terms by a small amount. 

Furthermore, if you aren’t exposing your wealth to enough risk, its growth may not keep up with the increase in prices. This means that over time, your money is losing its buying power. 

1. You may not have enough for a comfortable retirement 

After a life of hard work, retirement can be a great time to relax, put your feet up, and enjoy the fruits of your labours. You may already have thought about how you’d like to spend this chapter of your life, whether that’s taking long foreign holidays, mastering a hobby, or simply spending more time with loved ones. 

No matter how you choose to enjoy your retirement, it’s important that you have enough wealth to support your desired lifestyle in a sustainable way. This is why it’s important to build up your wealth effectively throughout your working life. 

In the long term, overreliance on low-risk investments could mean that your pensions don’t grow as effectively as you need them to. This could mean that you may not have enough to support your desired lifestyle when the time comes to retire. 

Please note: 

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. 

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.