The chilli rating system is based upon a system used across the fund management industry (the Synthetic Risk and Reward Indicator) and is used to classify investment funds into varying risk levels – to show how high or how low risk they are. This is to ensure that the volatility of funds is assessed using common methodology. It provides a number from 1 to 7, with 1 representing low risk and 7 representing high risk based upon volatility of the fund over a five year period. Volatility is not a reliable guide to all of the risks presented by a fund.
Funds are made up of a collection of individual assets, which may include some or all of equities (shares), corporate bonds, property, or gilts for example. As funds are made up of a number of individual assets, some types of risk may be mitigated by diversification. This means they are likely to be less volatile than individual equities because each of the assets within the fund will perform differently at different stages of the economic cycle. In the app, these risk levels are represented by chillies! The more chillies, the higher the risk. But remember – with higher risk comes higher rewards, as well as a higher risk of failure.
As mentioned above, it only applies to funds. Individual equities are likely to be more volatile than funds. The value of shares and any income from dividends can fall as well as rise. Because you are investing in a single company you will be more exposed to concentration risk, ie the failure of the company in which you are investing, as well as market risk, the rise and fall of markets in general based upon a number of factors. Other risks specific to that company, or the sector in which it operates, may also apply
– from changing consumer demands to new regulations, different things can impact whether the price of a stock or fund goes up or down. For investors, there is a way to determine how much risk you are willing to take on: your risk profile. We analyse what this is below.
The risk of an investment is the uncertainty around the future returns of that investment. The specific level of risk will be determined by the amount of things that can impact its future profitability, as well as how large and realistic those risks actually are.
For investors, risk is typically divided into three groups: Conservative, Moderate, and Aggressive. The amount of risk you take will reflect the potential earnings you can make in the future. The more conservative, the less the expected future returns.
Conservative investors try to play things as safe as possible. They might invest mostly in government bonds from developed economies such as the UK or the US, or perhaps in stocks from large companies that are more likely to be around in the future. Their exposure to riskier stocks will be very low. The fewer the chillies shown on a Theme, the more conservative it is.
Aggressive investors will put a lot of their money into stocks that look like they have large potential but have not yet delivered returns, for example niche technology stocks. Aggressive Themes are the ones that have the most chillies associated with them.
Finally, moderate investors will seek to blend the two activities in order to provide some stability in their returns with reduced risk in some areas, while still being exposed to some stocks and funds that are a bit riskier but could also deliver higher returns. These are shown as the Themes that have an average/medium amount of chillies displayed.
A lot of factors come into play here, including: your age, salary, and your savings goals. Typically, the younger you are, the more risky you can afford to be. This is because you will have more time in the market to make up for any potential losses.
Risk comes from not knowing what you're doing.
- Warren Buffett, Billionaire Investor
If you are investing towards a specific goal, then you may want to be less risky so that you can make sure you will earn the required amount at the time that you need it.
With regard to investment in equities you should bear in mind the following specific risks:
· Equity markets may fall in value
· Dividend growth is not guaranteed, nor are investee companies obliged to pay a dividend
· Companies may go bankrupt rendering the original equity investment valueless
· Individual equity prices can go down as well as up
· Corporate earnings and financial markets can be volatile
· Where investments in overseas companies are concerned, foreign exchange rates may move in an unfavourable direction adversely affecting the valuation of investments in currency terms
Individual equities are made available on the Wombat Platform on a direct offer basis and you are responsible for ensuring that your selection is appropriate to your needs and circumstances. We will conduct trades on an execution-only basis on your instructions transmitted through the platform. We do not offer financial advice. If you are in any doubt about how to proceed, you should consult a qualified independent financial adviser, used to advising on individual shares.