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Investing by oneself has become more popular than ever, with the rise in technology it has become easier to access information on almost every topic in the world, even such as this article based on financial education!
There is no denying the digital revolution is well upon us, but when researching how to invest or where to invest, it can still be a daunting task. Today we will discuss one of the most important topics around investing and that is understanding the concept of risk profiling, which along with further education can enable you to make more informed decisions on your wealth creation journey.
Risk tolerance is a very important aspect of the first steps to investing. Depending on your age, income, investments, and goals, you will fall into one of five risk categories:
The easiest way to get a feel for which end of the spectrum you fall is to go by age as when it comes to investing, especially for the long term which is how we accrue future wealth, it is often about the old adage of “the sooner you start the better”.
If you’re young and have a long time horizon, you should have the ability to be aggressive, while if you are older your time horizon would be shorter as you want to protect the capital you have accrued, this meaning you should be more conservative.
Let’s briefly discuss the five different risk profiles and how to manage that risk:
If you are an aggressive investor it is quite simple to make your investment choices. You have time, and have an appetite for risk and that means you would want your investments to be in riskier assets such as equities or properties and little to none in cash and bonds which are traditionally very safe investments. Another way to diversify is not necessarily stock pick but make use of ETFs and/or mutual funds.Keep in mind that you would still want to have a conservative emergency fund (preferably three to six months of your expenses) and build assets up.
Moderately aggressive investor:
You are well into your working career and are putting a substantial amount of your income after expenses into investments, this phase, much like being an aggressive investor still focuses on capital creation via riskier and growth based investments. A moderately aggressive risk profile generally comprises about 70-80% equities and the rest remains in fixed income such as corporate or government bonds which still carry some risk but yields superior returns to cash investments.
When you are +- ten to twelve years away from your ideal retirement age, you would’ve taken substantial risk with aggressive investments for a good decade or two and would have hopefully been rewarded for that risk appetite. Generally at this phase you would switch into a more moderate investment stance, perhaps lowering that equity exposure to around 50-60% of your portfolio as you are ideally getting to a place of financial security.
Moderately conservative investor:
When you are +- eight to ten years out from your ideal retirement age you would generally consider shifting into a moderately conservative wealth creation stance, this entails possibly starting to sell out from equity funds and focus on squashing any left over debt, perhaps keeping around 30-40% left in equities or pure growth generating investments or funds. Balanced cautious funds become popular to the moderately conservative investor as well as holding large cap stocks that do not fluctuate or carry as much risk as mid or low cap stocks. Utilizing fixed deposits/bonds and opening more exposure to safe cash investments generally become more popular during this phase of your financial life.
By the time you are within a few years of retirement, your assets should generally be made more conservative by utilizing cash funds or low risk investments to avoid any potential market downturns and unwanted losses. You are now entering a wealth preservation phase of your financial life and ideally do not want more than 10-20% left in equities or capital growth based assets. Five to seven years prior to your retirement you want to start preparing yourself. During these years, you do not want to lose money while you plan your retirement lifestyle and income needs. After a few years of retirement, you can actually start to take on more risk if your debt has been minimised or depleted and have enough cash to draw a sustainable income that can increase in line with inflation.
It is important to be educated on various risk profiles and the concept of time horizons in investing and how asset classes differ. We will discuss asset classes in more detail in future articles.