Are you considering investing for the first time? Or maybe you are already investing, and you’d like to learn more about your investment risk profile?
Here’s a quick guide from our SHARE advisers, to get you started.
Understanding investment risk
In short, all kinds of investments come with a risk-return trade-off. This means that all investments – including KiwiSaver – entail a certain degree of risk: the higher the (likely) risk, the higher the (potential) return.
Share markets fluctuate all the time based on a variety of factors, and when investing, it’s normal to go through downturns and upswings. With this in mind, some investment assets are likely to fluctuate more than others in the short term, but they’re also more likely to deliver higher returns in the long term.
The key is to choose investments that are suitable for your needs, goals and most importantly, your risk profile.
What’s your risk profile?
Your risk profile is a crucial component of your ‘investor personality’. There are two elements to it:
- Risk appetite – How willing and prepared you are to take a certain level of risk with your money (which has a lot to do with how you feel about market volatility);
- Risk tolerance – The amount of market risk that your investment can withstand, based on your goals and time horizon, which is the point in time when you hope to achieve those goals.
In a nutshell, it’s important to choose an investment strategy based on the ‘risk and reward’ balance that you’re comfortable with. If the level of risk is ‘too low’ for your risk appetite and tolerance, you may miss out on potential returns. And if it’s ‘too high’, you may suffer losses that could have been minimised – or you might even make impulsive decisions that ultimately damage your investment strategy.
Questions to help you determine your risk profile
As we’ve seen, your risk profile is determined by your emotional response to risk on one side, and by your investment goals on the other. So here are some questions that can help you identify where you stand:
- What are your investment goals?
- What returns are you looking at achieving?
- How long would you like to invest for – short, medium, or long term?
Generally speaking, the longer your time horizon, the higher the level of risk you may be comfortable to take. For example, if you’re 30 and your goal is to create a nest egg for retirement, you have an investment horizon of over 30 years – and you can probably afford to be as ‘aggressive’ as your risk appetite allows.
Minimising risk without compromising wealth creation
While investment risk can’t be totally avoided, it can be managed and minimised. There are different strategies to reduce the level of risk in your portfolio while trying to attain the level of return you expect.
One of these strategies is asset allocation. This means fine-tuning your investment portfolio to get the right balance of risk, by investing in a mix of different asset classes (like shares, property, mutual funds, gold and so on). For example, if your goal is to pursue growth and you’re willing to take on market risk to achieve it, you may decide to allocate 80 per cent of your assets in shares, and the remainder in (lower risk) bonds. Over time, as your investment horizon shortens, you can gradually reduce risk exposure.
Once you’ve allocated your assets, you can further minimise the overall investment risk by diversifying your investment within each asset class. Diversification may help lessen the impact of major market movements on your portfolio. For example, if you buy shares in a number of companies across different industries, the return on one may help offset a lacklustre performance on another.
Of course, if you invest in a managed fund, the fund manager takes care of the asset allocation and diversification for you. You just need to make sure that the fund you invest in is consistent with your risk profile – and once again, we can assist you with that.
Like to learn more?
Get in touch. As always, our SHARE financial advisers are just a phone call away. We can talk through your options and help you understand your risk profile, as well as what investment strategy may be most effective. Click here to find an adviser near you.
Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.