Your view of risk in finances is personal. It’s one that’s often influenced by emotions, but other areas should play a role too. When you’re considering how much risk to take, what factors influence you?
We all know that taking too much risk for your situation can lead to losses. However, so can not taking enough risk. Rising inflation means the spending power of cash is eroded. With low interest rates, many cash savings have lost value in real terms in recent years. Investment returns that don’t keep pace with inflation can effectively mean your investments are losing value.
Generally, the higher the risk you take with investments, the greater the potential returns. Of course, the more risk you take when making investment decisions, the more volatility you’ll be exposed to. As a result, there’s a higher chance that you’ll see the value of your investments decrease.
When you think about the level of risk you’re willing to take, it can often initially be reactionary. However, considering other key factors that may influence your decision can help set a risk profile that suits you.
Capacity for loss
All investments come with some level of risk. Understanding what you can afford to lose should be a starting point. Naturally, those with a greater capacity for loss can usually afford to take more risk.
Historically, stock markets have shown a long-term upwards trend, with dips smoothing out when you look at the bigger picture. However, this isn’t a reliable indicator for the future and there’s always a chance that you will want to withdraw when the market is at a low, meaning the value is decreased.
Looking at your capacity for loss can help you make an informed decision about whether higher potential returns are worth taking on extra risk. Looking at investments in the context of your whole financial situation is crucial, particularly when weighing up volatility.
Portfolio diversity
Where your existing investments are should influence decisions, whether you want to expand or reassess your portfolio. Ideally, your portfolio should be well balanced with a mix of different risk profiles. This allows you to take advantage of growth opportunities while still having some stability.
If, for example, a portion of your investments have a lower risk profile and provide a relatively reliable return, you may be in a position to invest in some riskier assets. Conversely, if much of your portfolio is already in high-risk investments, it may be wise to look at those that are exposed to less volatility.
Of course, whether your entire portfolio leans towards a more cautious or riskier approach will depend on you.
Investing length
You should be investing with a plan, and that includes a timeframe.
The longer you’re investing for, the more time markets have to recover from troughs. As a result, it’s generally advised that the longer your money will be invested for, the more risk you’re able to withstand. This is because your investments have a greater opportunity to recover in value.
You should begin investing with a minimum timeframe of five years. If you plan to withdraw from the investments after a five-year period, a lower level of risk can help reduce the chance of your assets decreasing in value. Alternatively, if you plan to hold investments over decades, more risk could result in higher returns in the long run.
Purpose of investments
It’s natural to want to take more or less risk with investments depending on what you intend to use the money for. Parents, for example, will often want to take a more cautious approach when growing a nest egg for their child’s future. In contrast, if you’re on track for a comfortable retirement and are investing so you have more to spend in the early years, you may be inclined to seek higher risk opportunities.
This is all about your personal view on how important the money is. Your investment portfolio should have a purpose, allowing you to understand what level of risk you’re comfortable with and how it could affect your long-term financial security.
If you’d like to discuss your investments and the level of risk you’re currently taking, please contact us. We’ll help you assess your risk profile in the context of your financial situation to strike the right balance.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
