Risk is a prerequisite of investing. That’s why all financial websites and products are plastered with disclaimers warning that the value of investments can go down as well as up, that past performance is no guarantee of future returns…etc, etc. If a financial professional tells you that you can invest without incurring any risk, run! They are lying.
If you’re risk-averse – and many of us are, even more so after the 2020 we have endured – that element of risk can be offputting to the extent that you avoid investing in stock markets altogether and stick to savings options that you consider to be less risky. If that’s you, you’re not alone. A 2019 survey in the US by MagnifyMoney revealed that 60% of Americans feel anxiety about investing in the stock market.
The problem is that your reluctance to embrace investing may be costing you when it comes to retirement savings. In order to achieve a secure financial future you need to balance risk and return in a more effective way than amassing large amounts of cash in low interest, supposedly safe savings accounts. In actual fact, they aren’t safe at all because of inflation, as our consultant, Verena Malherbe explains here.
And yet investment is essential in order to achieve a secure financial future. So how do you balance risk and return in a way that works for you? These are the questions you need to ask yourself.
The six questions to ask when working out how much risk you can take
1. How much risk can you afford?
In most cases this is directly related to how much you earn. Someone with a decent salary and high disposable income each month can absorb any losses incurred by taking investment risks much better than someone struggling to make ends meet. Low earners who have little leftover for saving each month will want to opt for a safe investment with very low downside risk.
2. What is your investment timeframe?
As a general rule, the younger you are, the more risk you can afford to take as you have much longer to recoup any losses. It’s obvious that a sixty-something coming to the end of their career will want to invest their savings more cautiously than a 25 year old just starting on the career ladder. Losing 20% of the value of investments at 25 will have little impact in the big picture because there are still decades left to ride the ups and downs of the market. This is not the case if you’re retiring in the next few years. At that stage a 20% loss in the value of your investments is catastrophic. The shorter your timeframe the more risk-averse you need to be.
3. How much risk do you need to take?
The risk you need to take to reach your financial goals is also known as risk capacity. There’s no point in putting money into high risk funds if your goals can be achieved in safer ones. This requires having clearly defined financial aims and a prescribed timeframe within which to achieve them.
4. How well is your existing wealth protected?
Wealth protection is an important foundation of any financial plan. With the security of a generous emergency fund behind you and adequate peace of mind insurance (life insurance, critical illness and income protection cover) you may feel secure enough to push your risk tolerance up a level.
5. How liquid do you need your investments to be?
Your capacity for risk decreases when your need for liquidity increases. To give an example, if you are saving for a deposit on a house, putting the money saved into a high-risk investment is a bad idea because you may find that the value of your investment tumbles just when you think you’ve got enough saved and have found the house of your dreams.
6. Are you an inherent risk-taker?
Some of us thrive on the threat of danger while others prefer to feel safe and secure. If you are drawn by the thrill of taking a risk on your investments and you feel you can tolerate the potential losses then by all means take a gamble but be prepared to swallow the potential downside and don’t risk anything you can’t afford to lose. If seeing the value of your investments swing wildly sends you into an emotional panic it’s probably best to avoid anything high-risk.
Defining a financial strategy that works for you involves striking a delicate balance between your capacity and tolerance to risk and the return you need to produce to meet your financial goals. If that feels daunting, perhaps its time to seek professional help?
Here at Infinity we use sophisticated risk profiling tools to establish our clients’ tolerance to risk. Our financial advisers have a wealth of experience in helping expats and locals in Asia to find that balance and propose investment products which are a good fit for their unique circumstances.
These include multi-asset portfolios offered by our investment management partner, Tilney. Tilney offer a range of actively-managed portfolios to suit different investment strategies so however much risk you want to take, there will be one that is perfect for you.
Why not get in touch and find out how we can help you solve the risk-reward dilemma and put in place a savings and investment strategy with a level of risk that works for you?
A leading provider of expat financial services and wealth management services across Asia.