Building The Right Investment Portfolio To Achieve Your Goals
Assessing how much risk you are willing and able to take can be complex, although three basic questions need to be answered:
1. How able are you to deal with the ups and downs of investment returns?
2. How much can you afford to lose?
3. What returns do you require to meet your objectives?
Risk tolerance – how much risk are you willing to accept?
The first question addresses your psychological ability to tolerate the ups and downs of investment performance. Understanding your personal risk tolerance is fundamental to ensuring you are satisfied your with investment outcomes.
Risk tolerance is not just an economic concept, it’s a psychological consideration too. Over 100 years of research into measuring psychological differences between people has yielded principles that define good practice. This is the field of psychometrics, which means the measurement of the mind. These principles should underpin a risk-profiling methodology.
Risk capacity – how much risk are you capable of taking?
This question defines your capacity for loss. While you may be willing to take a high level of risk, you need to balance this with the potential for loss. Your dependency on the income from your portfolio, or how quickly you will need to withdraw capital, will determine your capacity for loss.
No one should ever recommend an investment that exposes you to greater risk than you can tolerate or have the capacity to manage.
Risk requirement – how much investment return is required?
The third question focuses on your short, medium and long-term goals and the required investment return to achieve them. Even if you have significant capital working to achieve your goals and a willingness to take a high level of risk, it is always advisable to take no more risk than absolutely necessary. This is because higher risk introduces increased uncertainty, which leads to a greater range of potential outcomes. The result may be significantly above, or significantly below your financial objective.
If the risk level in the portfolio is higher than you wish to tolerate or exposes you to the possibility of unacceptable financial hardship, it is vital your financial goals are evaluated, assessed and prioritised. Seeking professional financial advice will help you understand and answer these crucial questions. A Financial Adviser’s work will form the foundation of your personal risk profile.
Mapping an accurate asset allocation that will perform within your expected range of risk tolerance and capacity is what separates a professional investment portfolio from the rest.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.