If you’re investing for the first time – or simply brushing up on your knowledge – you’ve probably come across the term ‘attitude to risk’.

What might sound like another piece of industry jargon is actually a crucial part of making sure your investments suit your needs.

So, what do we mean by attitude to risk? And how do you work out what your own attitude to risk is?

Read on for a simple explanation.

What’s attitude to risk and why is it important?

Your attitude to risk is one of the most important factors to consider when you’re building and managing an investment portfolio (another one is your financial goal, which we’ll come onto shortly). By thinking about your attitude to risk, you’re more likely to end up with a portfolio that’s right for you.

Your attitude to risk is partly psychological – how you feel about risk and how much risk you’re willing to take with your money. Understanding your emotional ability to bear losses can help you choose the investments that you’re comfortable with. This is more likely to lead to a positive experience as an investor (and fewer sleepless nights).

But it’s also about your ‘capacity for loss’ – or, to put it simply, how much you can afford to lose. If you’re retired, for example, would realising a loss have a material impact on your standard of living? Or if you’re nearing your financial goal, would you still be able to achieve that goal if your portfolio fell in value?

How do I work out my own attitude to risk?

Your own attitude to risk will partly reflect your personality. You might be naturally cautious and prefer not to take risks with your money. Or you might be more of a risk-taker and willing to accept fluctuations in value to try and achieve better long-term returns. A lot of people will fall somewhere in between.

Your investment experience and knowledge could also play a role. A new investor might feel nervous about risk to begin with but gain confidence as they learn about the potential benefits of investing over the long term.

Your attitude to risk should also reflect your financial goal. In general, the further away your goal is, the more risk you can afford to take on, as you have longer to recover from any dips in performance. A young person who is saving for retirement can typically afford to take on more risk than someone who is retiring in a few years’ time.

As you near your goal, it often makes sense to start reducing the level of risk in your portfolio. Even if you’re a risk-taker, it’s wise to take a cautious approach when goals are less than five years away. This is because there might not be enough time to recoup losses. The last thing you want is for your portfolio to drop in value just before you need to access it.

Meanwhile, a naturally cautious person might be comfortable taking on more risk when it comes to longer-term goals, like saving for retirement, in the belief that it will lead to better returns over the long run.

Which investments are right for me?

So, what does all this mean in terms of choosing specific investments?

First and foremost, it’s important to make sure you have a balanced portfolio – one that spreads your money across different assets, sectors and regions. When one asset, sector or region underperforms, the others will hopefully outperform. This helps to soften the impact of losses and lead to a smoother overall performance.

How much of your portfolio you invest in certain assets will depend on your goals and attitude to risk. Let’s take shares and bonds¹ as an example. Shares have historically offered higher returns than bonds over the long term, albeit with greater volatility (or swings in prices) along the way. Bonds have historically offered lower but more stable potential returns than shares.

Someone with a long-term goal and who is willing and able to accept the risk that comes with investing might allocate more of their portfolio to shares than bonds. That could be 80% shares and 20% bonds or, for a more moderate portfolio, 60% shares and 40% bonds. In contrast, someone with a short- to medium-term goal, or who is more cautious, might skew more of their portfolio towards bonds.

How do I get started?

There are a range of options to consider when it comes to building an investment portfolio.

At Vanguard, you can do it yourself by choosing from our wide range of low-cost individual funds. Or you can keep things simple by picking one of our five LifeStrategy funds, which mix bonds and shares to balance risk and reward.

If you want more of a helping hand when you invest in an individual savings account (ISA) or personal pension, our managed service will select investments within those products based on your attitude to risk. We start by asking you a few questions to understand how you feel about risk and then use those answers to match you with one of five portfolios.

It’s all about selecting the option that you feel most comfortable with.

¹ Bonds are a type of loan issued by governments or companies, which typically pay a fixed amount of interest and return the capital at the end of the term.