Investing for the future or to generate income to live on now requires careful planning, and it is essential that you make the right decisions so you do not regret them later.
One of the key ingredients to ensuring you are comfortable with your investment choices is understanding your attitude to risk, and while this may seem an easy thing to do, it can be harder than you think.
For example, you have to answer a variety of questions honestly, such as how you would really feel if the markets halved overnight, taking your investments with them. Or that you had seen a particularly risky market rise stratospherically, and been disappointed to miss out on some of those returns.
It is far too easy for most of us to take a ‘middle of the road’ approach and play it safe with a balanced portfolio, which to be fair might be the right choice for a lot of people. But with a higher degree of safety comes statistically lower returns, so it may not be as simple a choice as you think. Conversely, the more risk you are prepared to take, the higher the potential returns could be, but the chance of losing money is also increased.
To understand your attitude to risk, you need to consider a wide variety of factors, including your age, why you are investing, how long you are able to invest for, whether you are looking to extract the money from your investment at a particular time, and whether you need income or not. If you are investing for retirement but are still in your early 30s, you can afford to take more risk than someone in their late 50s, because if markets turn against you, you have more time for your portfolio to recover those losses.
You should also consider how much risk you are willing to take and with what proportion of your portfolio. For example, if you have a large portfolio then you may be willing to put a small amount of money into a very high risk area, as that could potentially give you higher returns but reduces the overall risk you are taking because of the relatively small amount of money you are risking.
Your overall financial status needs to be considered when you are trying to understand the amount of risk you are willing and able to accept, and this is where a good financial adviser will come into his or her own. They will be able to look at your entire financial landscape and recommend a course of action that not only fits with the amount of risk you are willing to take, but the amount of risk you should take in relation to your overall financial position.
Investors will generally be categorised as low, medium or high risk and the level of risk you are comfortable with will probably change as you go through your financial life. So it is important to reassess the risk you are taking with your investments not only as you get older, but as you go through life stages, such as getting married, having children, or simply moving to another country.