Understanding Your Risk Profile

Understanding Your Risk Profile

One of the crucial elements of successful investing is understanding your risk profile. How willing are you to accept fluctuations in the value of your investments?

The problem with risk profiling is that an investor’s risk tolerance is dynamic. Interestingly, in a bull market, when asset valuations tend to be higher, investors are often more willing to take on a higher level of risk. In a bear market, however, when valuations tend to be lower and therefore asset prices less expensive, investors tend to be more risk averse. In essence, our risk tolerance tends to increase at the exact time we should be scrutinising our portfolios the most!

So, how do we get away from this way of thinking? One way is to set a savings goal and only take as much risk as is needed to reach your target. Even as markets move up and down, the overall level of risk will remain the same. That way, you are not tempted to stretch your risk tolerance just because markets are strong.

Another way to look at your risk profile is to look at age-based risk profiling.

If you are a younger investor, you might be more willing to take on a higher degree of risk because you have a longer investment time horizon, greater earnings capacity and more time to ride out the volatility in markets.

As you get closer to retirement and start looking at pensions and how much you need in retirement, your risk profile is likely to become a little more conservative. This is simply because losses at this later stage of life are harder to recoup as there is less time available.

Once you reach retirement, your savings need to serve two purposes. You still need to earn a return from your investments to ensure they’ll last the distance. But at the same time, you need to be able to make regular withdrawals in order to fund your lifestyle since you no longer have an income. Finding the right balance between investing for the long term and retaining short-term access to your money can be difficult.

With an ageing population and people living longer, you need to manage your pool of savings by targeting a certain level of earnings. What does this mean? If you are a risk-averse investor, who avoids shares and other more volatile investments, you potentially run the risk of outliving your savings. You might want to consider holding a portion of higher risk investments in order to meet your overall retirement needs; being mindful, however, to limit that exposure to manage any market volatility.

Whatever your stage of life, it’s important to discuss these issues with us to make sure your investment strategy reflects a risk profile that’s appropriate for your situation.

Source: IOOF