15th Dec 2020
Understanding risk tolerance
Risk and reward often go hand in hand when it comes to investing. You will often see three different investing approaches; cautious, balanced, and aggressive. Therefore, before making an investment, it’s important to know how much risk you are willing to take. You need to know your risk tolerance.
What is risk tolerance?
Risk tolerance is simply the amount of risk an investor is comfortable in taking; it’s the degree of uncertainty you’re willing to handle when investing. It is important that crew speak openly to their adviser about their tolerance to risk. This is why it is good to consider your preference prior to engaging the services of a professional.
A person’s level of tolerance often varies with age, income and financial goals. For example, if you have a financial goal with a long-term horizon, you may make more money by carefully investing in higher-risk assets. Alternatively, lower risk cash investments may be appropriate for short-term financial goals. You are unlikely to have an aggressive approach with money you will need in the short term or money you can’t afford a short term loss on.
An aggressive investor, or one with a high-risk tolerance, is willing to risk losing money for potentially better results. A conservative investor, or one with a low-risk tolerance, favours investments that provide a lower return in exchange for reduced risk.
Assessing your tolerance for risk
Taking the time to understanding and measuring your risk tolerance is important. It may also require some self-discovery as you need to know what worries you most when it comes to investing.
Here are some questions you can ask yourself to better understand your approach to risk:
- What keeps you awake at night?
- Are you more concerned about losing your money or about losing your purchasing power?
- And just how much are you willing to lose?
- When assessing your capacity for risk, ask yourself: is time on my side?
- Do I have many years to invest?
- Or will I need to take money out of my investment account soon?
A cautious approach to investing
“Don’t put all your eggs in one basket” is advice which every investor should take onboard. All markets have ups and downs tied to the economy, interest rates, inflation or other market trends. There will always be a Black Swan which shakes even the most unstable of investments.
As an investor, you can’t eliminate market shocks, but you can hedge your bets against booms and busts with a diversified portfolio and strategy based on general market conditions. A diversified investment portfolio carries a significantly lower total risk of loss.
Understandably, global events like the COVID pandemic have made some people fearful of investing. Many don’t know what action to take.
However, over time, markets generally recover from losses and the number of positive years far outweighs the negative. When assessing your risk tolerance, another question to ask yourself is: am I willing to remain invested during down markets?
No such thing as a risk-free investment
Keep in mind that no single investment type is 100% risk-free. For example, investing in property is historically seen as more stable and over long periods can achieve high returns. However, it also carries inherent risks.
It is easy to assume that, with growing property price averages, buying a property and sitting tight will guarantee you a profit. But it isn’t always so straightforward. Some properties still haven’t recovered to their previous high following the 2008 global financial crisis.
There are also costs such as maintenance and refurbishment to consider, as well as a ceiling value. Some properties simply will never get more than a certain value when sold due to the area they are located in. These are all things to consider when investing in property.
Many people consider gold as a safe haven when investing, especially during crises like a pandemic. Compared to an investment in stocks, an investment in gold is often considered less risky for its reliable store of value. However, the entry point for investing in gold is high and it doesn’t pay a dividend or interest.
Work with an investment professional
The first step to investing is to have a financial plan.
You need an accurate picture of your overall financial situation, including how much you have available to invest and for how long, as well as your tolerance for risk. Working with an adviser can help you achieve this.
Get in touch
If you are keen to better understand your financial situation and risk tolerance, please contact our team of experienced financial advisers.
Nothing in this article represents an inducement or incentive to purchase the investments mentioned. You should always speak to a qualified adviser before investing.