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All investors have differing attitudes towards risk. When it comes to investing, it is important to consider your risk tolerance carefully, including how comfortable you are with the chance of losing money, or that returns on your investments could vary widely from year to year.
Choosing an appropriate asset allocation - the following points can help you to determine an investment mix that's appropriate for your needs.
Investment Experience
How would you describe your investment experience and understanding of financial markets?
- Just started investing in the last year
- You understand the basics of investing
- You have been investing on your own for several years and are reasonably confident of your knowledge of financial markets
- Your knowledge of financial markets is well above average and you make investment decisions confidently
Risk Tolerance
To establish an investment strategy that you will be comfortable with you need to consider the possibility that the value of your investment may decline even though this may be temporary. Are you prepared to accept the possibility of a negative return at any time in exchange for potentially higher long term returns? What percentage of your money would you be prepared to invest in higher-risk investments?
Which of the following is important to you:
- Avoiding any short-term losses
- Receiving regular income from investments
- Long-term growth in the value of investments
- Protection against inflation
In October 1987 the stock market fell more than 20% in one day. If you owned an investment that fell by 20% in a short time what would you do or what did you do in 1987:
- Sell all of the remaining investment (Conservative)
- Sell a portion of the remaining investment (Conservative to Balanced)
- Hold the investment and sell nothing (Balanced or Aggressive)
- Buy more of the investment (Aggressive)
Investment Goals and Objectives
Why are you investing? Is it for something in the near future (new car, or down payment on a home) or something farther off (a young child's education or your own retirement)? If your investing goals are short term you want your money to be there - with interest - when you need it. Therefore you will need to focus on relatively short term investments like term deposits or a cash management trust. If on the other hand, you are investing for the long term, you may be able to afford to take some risk in pursuit of a higher return. Shares and property, which historically have provided higher returns than fixed interest or cash over time, may be more appropriate.
Investment Timeframe
When do you expect to need to access all or part of your investments:
- Less than 1 year (immediate access)
- Less than 2 years (short term)
- 2 to 5 years (short to mid-term)
- 6 to 10 Years (mid to long term)
- Over 10 Years (long term)
Liquidity / Cash Requirements
How much money do you need to keep available for emergencies such as house repairs, a dental emergency or serious car repairs? These emergencies can be a serious setback if you are not prepared. The amount of your emergency fund will depend on your current lifestyle and expenses. As a general rule you should have about 3 months of income set aside to meet emergencies. A cash management trust can be a good place to keep these funds.
Age and Income
Your age and your income - particularly the stability of your income - are important factors to consider when determining your investment profile. If you are young you can afford to take a longer term view and any short-term losses may have minimal effect. If your income or employment is unstable you will need to take this in to account when setting your investment goals.
Risk Profiles
Conservative
Your primary investment goal is capital protection. You require stable growth and/or a high level of income, and access to your investment within 3 years.
Cautious
Your primary investment goal is capital protection. You require fairly stable growth and/or a moderate level of income. Your investment term is 3 years or more.
Moderate
Your primary investment goal is capital growth. You can tolerate some fluctuations in the value of your investment in anticipation of a higher return. You don't require an income and you are prepared to invest for 5 years or more.
Moderately aggressive
Your primary investment goal is capital growth. You can tolerate a fair level of fluctuations in the value of your investment in anticipation of possible higher returns. You don't require an income and you are prepared to invest for 5 to 10 years.
Aggressive
Your primary investment goal is long-term capital growth. You can tolerate substantial fluctuations in the value of your investment in the short-term in anticipation of the highest possible return over a period of 10 years or more.
 | Guide to Understanding Investment Risk | | Understanding Risk Poster |
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