Risk means different things to different investors. For some, the greatest concern may be short-term falls in the value of their portfolio, while for others it may be inflation eroding purchasing power, insufficient returns to meet long-term objectives, or the need to access capital at an unfavourable time. Understanding an individual’s financial circumstances, objectives, time horizon and ability to absorb losses is therefore an important first step before considering the risks associated with financial markets, individual investments, and the portfolio as a whole.
Risk profile
An individual’s risk profile reflects both their appetite for risk and their capacity to take it. In tandem, they inform the level of investment risk which is suitable for each client. Some key determinants of each are highlighted below.
| Risk Appetite | Risk Capacity |
|---|---|
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Comfort with potential losses
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Level of Income relative to expenditures
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Financial literacy
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Savings in reserve
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Previous experience
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Debts and financial commitments
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Investment objectives
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Investment time horizon
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Financial market risks
While risk profiles relate to the investor, there are multiple financial market risks for investors to consider.
| Market Risk | Credit Risk |
|---|---|
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This is the risk that the value of an investment falls due to financial market movements. This could arise from changes in share prices, interest rates, exchange rates, alongside other market and macroeconomic factors.
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Credit risk is the risk that a borrower or issuer fails to meet its financial obligations, such as making scheduled coupon payments or repaying principal on a bond. This incurs a loss on the bondholder.
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| Inflation Risk | Liquidity Risk |
|---|---|
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Inflation risk is the potential loss of purchasing power that arises from the increased costs of goods and services.
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The risk that an investment cannot be sold quickly, and at a fair price, due to market conditions.
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Risk Characteristics of Different Assets
The riskiness of different assets varies widely from lower- to higher-risk investments. Generally, lower-risk investments, such as cash and short-dated, high-quality bonds, offer greater capital stability but lower potential returns. These investments can therefore play an important role in preserving capital and meeting shorter-term liquidity requirements, although the real purchasing power value of these assets may be vulnerable to inflation over time if their value does not keep pace with the price level.
Higher-risk investments, such as equities and commodities, offer greater potential returns but also carry greater risk of capital loss. Equities, for example, provide exposure to the growth and profitability of companies and have historically provided greater return potential than cash and high-quality bonds, but their market values can fluctuate significantly, and investors may experience periods of substantial capital loss.
The way an investment is implemented can also materially affect its risk profile and realised return. For example, investing in a single conventional UK government bond which is then held to maturity has a known redemption value and hence a defined return. By contrast, a UK government bond fund has no fixed maturity date. As bonds within the fund mature, the proceeds are reinvested into new bonds, and the value of an investment in the fund remains continuously exposed to changes in interest rates.
Diversification
In addition to understanding the risks inherent in individual assets, it is important to consider the overall risk of a portfolio. Diversification is a key tool for managing portfolio risk. By investing across a range of assets, investors can reduce their overall risk as different assets do not move in the same direction or by the same magnitude at the same time. This applies to investing across asset classes, regions and securities.
For example, investing in a single stock exposes an investor to significant company-specific risk. A diversified equity fund, by contrast, spreads exposure across many companies, reducing the impact of any individual company and instead providing investors with market risk which is more correlated with the private sector performance as a whole alongside the performance of the macroeconomy and wider investor sentiment. The chart below illustrates this principle by showing the path of returns, over 10-years to the end of September 2026, of Shell and the UK equity index. Over the long-term, Shell has outperformed the broader index but has exhibited much greater volatility.
Source: LSEG Refinitiv, North Capital Management. As at 30 Sep 2026. All figures in GBP.
Relationships between asset classes, regions and individual securities are not static. Correlations can change over time in response to economic conditions, market sentiment and the broader investment environment. Therefore, we believe that the active asset allocation we employ across our portfolio range can play an important role in managing these exposures and help to improve risk-adjusted returns over time.
Portfolio Risk and Time Horizon
Changing the weightings of assets within a portfolio can significantly change the overall risk and return characteristics. For example, increasing the allocation to equities while reducing cash or short-dated, high-quality bonds will generally result in a higher-risk portfolio, with the potential for larger drawdowns during periods of market stress. At North Capital, we manage a range of portfolios designed to meet the needs of investors with different risk profiles.
Historically, portfolios with greater exposure to equities have typically delivered higher returns over the long term than those with greater allocations to lower-risk assets. That said, the timing and magnitude of market drawdowns can also be important, particularly for investors who need to withdraw capital during periods of market weakness. For example, rolling monthly data over 30 years to the end of September 2026 shows that a basic balanced portfolio (comprising 60% global equities and 40% global bonds) experienced a maximum drawdown of -15.7% over any rolling one-year period. However, over 30 years there was no rolling five-year period that produced a negative return – demonstrating the benefit of a long horizon when taking investment risk.
Summary
Risk is multi-dimensional. Effective risk management begins with understanding each investor’s risk appetite and capacity for loss. Different asset classes carry distinct risks and return characteristics, while diversification can help reduce exposure to individual securities, regions and asset classes. Ultimately, the appropriate level of portfolio risk depends on each investor’s individual circumstances, which may change over time, and it is sensible to discuss regularly with your financial advisor.
