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Two Sides ...
Two Sides ...
Have you ever seen a one-sided coin? I didn't think so .... Everything has more than one side attached to it and investments are no different. We seem to have no trouble in understanding RETURN as it is splashed around on TV screens and billboards everywhere. However, it is rare to see anyone explain what are the RISKS we take to achieve those returns.
What is Investment Risk?
What is Investment Risk?
Most folk interpret investment risk as the chance of losing all your money! Although, Investment Risk can have this outcome, this is not the accurate meaning of the risk. Investment risk is a measure of the level of uncertainty of achieving the returns as per the expectations of the investor. In other words, it is the risk of getting something other than what you expect to get.
Example:
It is interesting to note that if you were expecting a return of 6% for the year and you received 12% instead, then your investment risk is high, although not many people complain if their money doubles. If you received 0% the investment risk is the same, but the complaints increase. Risk is the difference between what you get and what you expect to get.
Risk Strategies.
Risk Strategies.
There are probably many ways to try to reduce risks, however in financial planning there are three, often used strategies. They are Diversification, Time Horizons and Risk Profiles.
Diversification.
You know the story about the eggs in the basket? right?
If you want to keep your eggs, use a number of baskets!! If you drop one, then only those eggs are at risk. Diversify your investments and even the investment sectors to reduce risk.
Time Horizons.
This is a critical area to get right. Different investment sectors have a time frames attached to them. The reason is that investments move in cycles. The returns are up and then they move down and then up again and the time frames for investment cycles are different. Therefore, it is important that if your time horizon is short, you have investments with short cycles. Otherwise, just when you need your money to be high, it might be going through a low and that is disappointing.
Risk Profiles.
Now that we know to diversify and have our time horizons worked out, we need to try to determine our risk profile. There are 6 Risk profiles that Financial Planners use. These profiles start with Cash Profile and this is considered at zero risk. Then the profiles move up the scale, through the Balanced profile to finish at High Growth profile, which is considered the highest risk.
Actually, it doesn't matter how careful we might mix the diversification and time horizons and risk profiles, a person's risk tolerance is extremely personal feeling. If the adviser has done his best and you are still sleepless due to investment worry, then change the investment mix until you are able to sleep at night like a baby. You must be able to pass the "Sleep Test". No one knows your Risk Profile better than you!
Even though your profile will be a personal setting the planner uses 5 main profiles or guides to help you find your comfort level.
As mentioned before they are:
High Growth <--- Click on these links to see the profiles in more detail.
Your Risk Profile.
Your Risk Profile.
After you have looked at the profiles described above, you may be wondering as to which profile suits you?
One way to try to define which profile is geared to your attitudes is to complete a small questionnaire.
It is important to note that there are no WRONG answers to this questionnaire, however the responses are weighted to try to determine if you are a conservative or risk-taker type of investor. Also, the results of these questions are not fool-proof and you do not have to agree with the questionnaire results. But the results do provide an excellent starting point to assist you in settling on your investment Risk Profile.
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