Investing your money is an effective way to build your wealth. However, investing is intrinsically linked to taking risk. In fact, investment risk is defined as the chance you will either lose or make money on an investment. As all investments come with varying degrees of risk, it is important to recognise your appetite for risk and build a portfolio that suits your risk tolerance so you can sleep at night. There are several factors that measure risk tolerance.
Some investors enjoy the inherent uncertainty of investing and are inclined to take on high-risk investments. More common however is an aversion to the stress that a large fall in an investment’s value can produce.
A couple with a new baby and a mortgage will have a considerably different capacity to take risks than a single person just starting out in the workforce.
This is tied to your investment time frame. If you are 30 years old and planning 35 years ahead for retirement, you will probably be happy to accept greater risk, as short-term volatility is smoothed out, to achieve your goals. On the other hand, if you are nearing retirement, you’ll probably not want to risk losing your money as there isn’t the luxury of time to recover from losses.
With greater risk, there is the opportunity for greater returns. Different types of investments, or asset classes, have greater risk and the possibility of higher returns. There are four main asset classes:
Each asset class has individual characteristics and carries a different level of risk and return to suit a range of investor types.
While risk is an unavoidable part of investing, there are steps you can take to minimise your exposure to unintended risk through diversification and where possible, making longer-term investments.
Understanding what type of investor you are, and therefore what types of investments are appropriate to you, is all about your personal circumstances and your attitude towards investment risk.
A financial planner can help you understand your risk profile and build a portfolio of investments that matches your risk profile and your investment objectives.