Risk; When is the Right Time and How Much Should I Take?
Once you’ve established a comfortable relationship through the initial ‘getting to know you’ phase with a financial adviser, the conversation invariably shifts towards the critical aspects of ‘risk’ and returns. Simply put, discussions about future life goals, returns, and performance necessitate a comprehensive understanding of the concept of ‘risk.’
So, what exactly is ‘risk’? There are multifaceted dimensions to ponder when contemplating risk. For us, it encapsulates the probability of not recovering some or all of your invested capital. Intriguingly, certain factors contributing to ‘risk’ extend beyond the investment itself.
Whether it’s shares in a company or a property investment, success or failure can hinge on various external factors. These encompass interest rates affecting the cost of maintaining investment-related borrowings, government policy changes, regulatory shifts, and the overall consumer spending mood. These external variables have the potential to disrupt what initially appeared to be a ‘sure thing.’
Setting aside these external factors, a financial adviser should delve into the factors that drive you. They should explore how you respond positively or negatively to investment outcomes surpassing or, more significantly, falling short of your expectations.
Outlined below are crucial concepts within your control that should guide your investment decision-making process. Minimising the ‘risk’ associated with investment decisions.
- Ability to take risk: Consider a common scenario where someone needs to allocate a substantial portion of their capital within the next six months for a property purchase or some other large commitment. The pressing question arises: “Where can I invest to secure a good return before I need to make the property purchase?” Irrespective of how promising a short term share or property investment may seem, such a brief timeframe makes the strategy exceptionally precarious. Especially in markets that have experienced more than a 20% decline over short periods. Opting for a bank deposit return may be a prudent choice for a more certain short-term, albeit limited return, outcome.
- Willingness to take risk: Termed as the ‘sleep at night factor,’ this involves introspection on how comfortable you would be witnessing the value of an investment decline by a specific amount over short periods. Contemplate the possibility of 5%, 10%, or 20% falls and assess your experience with such levels of volatility. Would you find such movements intolerable, even if the investment thesis remains true? If so then you are now naturally ‘self selecting’ into a more conservative market exposure.
- The need to take risk: This factor is pivotal in determining the level of risk one might need to take. For instance, consider a scenario where an individual lacks sufficient capital to sustain their lifestyle. If someone with $500,000 in retirement requires $100,000 annually, a 20% per annum return demands extreme risk-taking behaviour. In contrast, someone with $5 million needing the same annual income only requires a 2% return, indicating a lower need to take ‘risk’.
By carefully considering these three elements of risk, one can ensure that a portfolio is structured with an appropriate balance to defensive and market-linked assets.
About the Author:
Ben Devenish – Managing Director – Vantage Wealth Management
Ben, commenced work in the financial services industry in 1993 and has held Executive Director, Private Client Adviser, and Responsible Manager (RM) positions since that time. Key responsibilities as Managing Director at Vantage are to manage operational functions to achieve group strategic objectives, stakeholders are engaged to ensure aligned objectives are achieved, and most critically a team-oriented culture is fostered. Read more about Ben here.
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