Understanding investment risks and strategies for investors
16th November, 2023
Investing is a powerful tool for building wealth and achieving financial goals. However, it is essential to acknowledge that all investments carry some degree of risk. As an investor, understanding and managing these risks is crucial for successful investing.
Most investors would define risk as the possibility of capital loss or the variability in the value of their capital. True investment risk is far more nuanced than this. All investors desire high returns while taking a low level of (or even no) risk. This seems to be hard-wired into all human beings but is incongruent with the way financial markets actually work. Return without risk is impossible. Return without unnecessary risk is what most investors should strive for.
Types of investment risks
During your investment journey, you will encounter different types of risks. Some come from the broader economy and market ups and downs, while others are more related to your specific investments or personal situation. For instance, shifts in economic conditions like interest rates, inflation, foreign exchange rates, and the prevailing market sentiment can significantly influence the performance of your investments.
Conversely,there are risks that are more personal in nature. These include concentration risk, which arises when an excessive portion of your investments is concentrated in a single area, and horizon and longevity risks, tied to unexpected changes in personal situation and ensuring the enduring viability of your savings. Another important risk in this category is behavioural risk. Panic selling in a market downturn due to fear, frequent buying and selling while believing you are better than most investors, or making investment decision following the crowd all belong to this category. You can find a more detailed explanation of these risks in the appendix.
Assessing your risk tolerance
To make informed investment decisions, the very first step is to understand your risk tolerance—the level of risk you are willing to take. Several factors influence your risk tolerance, including your investment goals, age, financial situation, and investment horizon. To assess your risk tolerance, our trusted Advisers and financial planning specialists will work with you to understand your specific circumstances and you will be advised to take a risk profiling questionnaire, such as FinaMetrica or Oxford Risk, to gain valuable insights about your risk tolerance.
Strategies to manage risk in your portfolio
While risk is unavoidable, employing various strategies can help manage it effectively in your investment portfolio:
Avoid putting all your eggs in one basket by diversifying across different asset classes (e.g. stocks, bonds, commodities, properties) or countries/regions. Diversification reduces concentration risk and minimises exposure to a single asset.
Increase investment horizon
Longer time horizons allow investors to weather short-term fluctuations and benefit from potential market recoveries. Maintaining a long-term perspective can help reduce the impact of market volatility on your portfolio.
To manage horizon risk, it's recommended to set aside emergency funds to cover unforeseen expenses or financial emergencies. This ensures that you can continue your investment plan even during challenging times.
Seek professional advice
Engage with trusted financial Advisers or professionals who can help you assess your risk tolerance and tailor your investment strategy accordingly. At our firm, we have a dedicated team of advisors and an investment team of thirty professionals who manage client portfolios across various risk profiles, aiming to deliver world-class outcomes for our clients.
As an investor, understanding and managing investment risks are essential components of a successful investment journey. By familiarising yourself with different types of risks, assessing your risk tolerance, and employing effective risk management strategies, you can confidently navigate the world of investing and work toward achieving your financial goals.
Mary's investing journey - A hypothetical example
Let's take a look at Mary, a thirty year old professional with ambitious financial goals. Mary decides to embark on an investing journey to build wealth and secure her future. She begins by assessing her risk tolerance with the help of a financial Adviser, discovering that she is comfortable with moderate risk.
As her portfolio grows, Mary diversifies her investments across various asset classes, including stocks, bonds, and alternative assets including commodity, property, and hedge funds. She is aware of market risk and understands that market fluctuations can impact the value of her investments.
A few years into her investing journey, global economic challenges and currency fluctuations affect the performance of her international investments. Mary faces concentration risk when she realises that a significant portion of her investments is concentrated in technology stocks. To mitigate this risk, she decides to rebalance her portfolio and diversify into other sectors.
As Mary approaches her fifties, she becomes more focused on retirement planning and considers longevity risk. Working with her financial Adviser, she ensures her investment strategy provides sufficient income for her post-retirement years.
Mary's investing journey showcases the various risks an investor might encounter during their pursuit of financial goals. By understanding different types of risks, assessing risk tolerance, and employing effective risk management strategies, investors like Mary can confidently navigate the world of investing and work towards achieving their financial goals. Remember, investing is a journey, and with sound risk management, you can pave the way to a prosperous financial future.
Warning: The information in this article is not a recommendation or investment research. It does not purport to be financial advice and does not take into account the investment objectives, knowledge and experience or financial situation of any particular person. Investors should determine whether an investment is appropriate to their own personal circumstances.
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