Ask ten investors what the “best” investment is and you will get ten different answers. That is because the best investment is not the one with the highest return. It is the one that fits you.
Before choosing where to put your money, it helps to understand your risk profile.
What Is a Risk Profile?
Your risk profile describes how much ups and downs in the value of your investments you can afford, and are willing, to live with in pursuit of your goals. It is a mix of your finances, your goals and your personality.
Higher potential returns usually come with bigger swings along the way.
No profile is better than another. A cautious investor is not wrong, and a bold investor is not smarter. What matters is that your investments match your situation.
The Three Things That Shape Your Profile
- Your willingness to take risk. This is about temperament. If your investment fell by a fifth in a few months, would you stay calm, or lose sleep and want to sell?
- Your ability to take risk. This is about your finances. Do you have steady income, an emergency fund, and few debts? The more cushion you have, the more a temporary loss can be absorbed.
- Your time horizon. This is how long before you need the money. Money for school fees next year has very different needs from money for retirement in twenty-five years. Longer horizons give investments more time to recover from bad patches.
Your willingness and ability do not always agree. You may be comfortable with risk but have little financial cushion, or have plenty of cushion but feel nervous about any loss. In that case, go with the more cautious of the two.
The Three Common Profiles
- Conservative. You value safety and steady income over growth. You prefer your capital to stay stable and accept lower returns in exchange. Typical choices include treasury bills, money market funds and short-dated government securities.
- Moderate (balanced). You want growth but not at any price. You can accept some ups and downs for better long-term returns. Typical choices mix government bonds, balanced funds and some company shares.
- Aggressive. You are focused on long-term growth and can stay calm through sharp falls. You have a long horizon and a financial cushion. Typical choices lean towards company shares and equity funds.
Most people sit somewhere between these, and many hold a mix of all three for different goals.
Questions to Ask Yourself
- What am I investing for, and when will I need the money?
- How would I feel, and what would I do, if my investments dropped sharply in value?
- Could I cover my expenses for several months without touching this money?
- Does anyone depend on my income?
- Do I need regular income from this money, or can I let it grow?
Be honest. There are no right answers, only answers that help you choose well.
Common Mistakes to Avoid
- Copying someone else. A friend’s winning investment was chosen for their situation, not yours.
- Chasing last year’s winner. Past performance does not promise future results.
- Overestimating your comfort. It is easy to feel brave when markets are rising. Test yourself against the bad times, not the good ones.
- Selling in a panic. Locking in a loss during a downturn is one of the most costly habits for investors.
Your Profile Will Change
Your risk profile is not fixed. A new job, marriage, children, a business, or approaching retirement can all change it. Review it at least once a year and after any major life event, and adjust your investments to match.
The Bottom Line
Knowing your risk profile is the foundation of every good investment decision. It keeps you invested through the rough patches and helps you avoid taking either too much or too little risk. If you are unsure where you stand, speak with a licensed investment adviser who can help you assess your profile and build a plan around it.
Please visit Ficus fulcrum to know your risk profile.
This article is for general information and education only and is not personalised investment advice. Investments can fall as well as rise.