Do you risk your cash for a big return or stash it under a mattress?
Are you a slip, slop, slap or coconut oil kind of person? At a famous bungee jump, are you looking or leaping? Do sharks keep you on the beach – or does the extra rush make the board ride even better?
Find out how much risk you’re comfortable with using our really simple risk assessment tool below.
Money can similarly polarise people. And they might even be couples co-investing in joint pursuit of a comfortable future. I call your tolerance for risk your sleep-at-night quotient. Just how much risk – which you can really think of as the potential to lose money – you can handle without turning into an insomniac. A number of factors will shape this: nature, nurture and need.
We’re all born with a certain inbuilt propensity for excitement and danger, which you could equally consider risk. That’s “nature”. You’ll also have a learned propensity for excitement and danger, shaped and honed through your observation and experience of money and investment. Your parents’ influence, the way they dealt with it and when and how they exposed you to the concepts, was probably key. Financial stress, anxiety, foolhardiness, debt dependence – we unintentionally absorb or actively repel our parents’ economic attitudes. Behold “nurture”. And you’ll be contending with external factors that temper and may even override the previous two risk influencers. How old are you? How much money do you need? How soon do you need it? Yes “need”. These three vital factors will determine the right investments for you.
If you’re already thinking “shares are too risky for me”, you may be entirely wrong. Yes, the credit crack-up was confronting, but you need growth assets such as shares and property to reach your goals. The key is to balance these with more stable, income-producing assets. The fortunes of markets can turn on the head of a pin (witness share recoveries of 20 per cent in some 12-month periods in the years after the financial crisis) and you need to be invested to benefit.
More importantly though, if you have a safe, appropriate mix of investments in the first place, market fluctuations shouldn’t hurt you too much and it should be easier to psychologically cope.
So how much excitement can you handle?
Find out the ideal investment mix for you by using the tool below
A Word On Diversification
Whatever your sleep-at-night formula, diversification will assist your slumber. This means spreading your investments across the range of the asset classes mentioned above, so that a downturn in one will hopefully be cancelled out by gains in others. Think about whether they are really spread, too. If you have a home, an investment property or two, and a bunch of cash in mortgage trusts, you really hold only one type of asset – property. So that means you are vulnerable to a cyclical downturn in that asset.
You should also invest in different sectors within each asset class. For example, a spread of shares including resources, banking and, say, technology stocks, and not just residential, but also commercial property.
Finally, you need to consider the geographical bias in your portfolio. Australia represents only 2 per cent of the world’s market. Besides, if every one of your assets is in the one country, you are incredibly exposed to a local economic downturn.
Thorough risk profiling is rather more complex than this little exercise suggests. In fact, there is an entire academic discipline − psychometrics − dedicated to such psychological testing. You should also bear in mind that in most risk questionnaires, people come out as more risk-averse than they can afford to be. Remember: you need to be well rested and achieve your investment objectives.
Although a risk-free return of 5 per cent a year might sound appealing, it won’t be much good if you actually need 8 per cent to be able to retire when you would like. So you have to balance psychology with necessity. In a nutshell, if you are investing for the long term, you will need more exposure to growth assets; if you are investing for the short term, you will need more exposure to interest-bearing and other safer assets.
Once you have split your portfolio among the asset classes (then split it further among a big enough selection of top investments within those assets), you need to do your best to leave it there. Not necessarily in particular investments but definitely – until your risk profile changes – in the assets. Then sleep easy.