Investing can appear to be daunting and complicated. But it doesn’t have to be if you understand investing isn’t a one-size-fits-all game and knowing your risk profile makes your decision making so much simpler.
How much risk you’re comfortable with when putting your money to work cuts down your choices, makes choosing the right investment options a whole lot easier, and helps you sleep at night without stressing about every market gyration.
What’s your risk profile?
Your risk profile boils down to how much volatility you can handle, and it’s shaped by factors like your investment timeline, financial goals and how you emotionally deal with risk. Some investors are comfortable with the ups and downs of high-growth assets like shares, while others prefer the steady, reliable returns of more conservative investments like bonds or term deposits.
Can I say right from the start there is nothing more important than your health and emotional well-being. I don’t care if it’s the best investment in the world… if you worry about it and lose sleep, then it’s simply not worth it.
Spending time working out your individual risk profile is important because it helps you match your investments to your comfort level. It also means you’re not taking on more risk than you can handle. Let’s face it – there’s nothing worse than lying awake at night worrying about your investments. But with a firm understanding of your risk profile, you can sleep soundly knowing your portfolio is working in your favour.
Let’s break down a risk profile into three core elements:
- Investment horizon: How long do you plan to invest? If you’re in your 30s and investing for retirement, you’ve got time to ride out major market fluctuations, so you might be more willing to take on plenty of risk. But if you’re nearing retirement, you’ll likely want to protect your capital, making you a more conservative investor.
- Financial goals: What are you aiming for? Growth investors might seek capital gains over the long term, while others prefer more predictable income streams. Your goals play a huge role in determining how much risk you need to take.
- Risk tolerance: Some people can handle watching their portfolio dip in value without batting an eye, while others get stressed over the slightest market wobble. Be honest with yourself about how you react to risk.
Asset allocation based on risk
Once you know your risk profile, it’s all about getting the right mix of assets. Whether you’re conservative, balanced or growth-oriented, your portfolio will look different. Visiting a good Financial Adviser is important to get this right for you, but here’s a rough guide of what each of these portfolios might look like based on your risk appetite.
- Conservative portfolio: For those who don’t like volatility and want to preserve capital. It’s a decent portfolio for shorter-term goals or if you’re approaching retirement, and the mix looks something like:
- 70–80% in fixed income (bonds, term deposits)
- 10–20% in stocks
- 10–15% in cash
- Balanced portfolio: If you want a bit of growth potential with a safety net, you’ll get a mix of steady returns and some exposure to growth with a balanced portfolio:
- 40–50% in stocks
- 30–40% in bonds
- 10–15% in alternative assets (property, infrastructure)
- 5–10% in cash
- Growth portfolio: For investors with a longer timeline who can stomach volatility, a growth portfolio is ideal to maximise long-term gains:
- 70–80% in stocks
- 10–15% in bonds
- 10–15% in alternatives
Getting it right
Now that you know how to identify your risk profile and build a portfolio around it, here are some tips to make sure you stay on the right track:
- Revisit your risk profile from time to time: Life changes – and so will your risk profile. As you get older, your financial goals and ability to handle risk will likely shift. Review your portfolio and risk tolerance every couple of years to see if they still match.
- Diversify: Don’t put all your eggs in one basket. Spread your investments across different asset classes – stocks, bonds, property, etc. – to reduce risk. If one asset class underperforms, others will hopefully be able to offset the impact.
- Stay calm during market fluctuations: Markets will go up and down – that’s a given. If your portfolio matches your risk profile, trust the process and avoid knee-jerk reactions. Over the long term, markets tend to recover.
Once again, fine tune your risk profile with a good financial adviser but getting your risk profile right should be step one on your path to becoming a successful investor. It doesn’t matter whether you’re conservative, balanced or growth-focused – knowing your risk profile makes investing simpler and far less stressful.
So take the time to figure out where you stand. Adjust your portfolio when necessary. And let your investments work for you in the long haul.
