How much risk is right for you?

When investing your money

Four factors for risk

Whether you’re an existing investor or just starting out and you’re confused by all the ‘mumbo jumbo’ jargon of investing, don’t worry …

…most people, including a lot of advisers are confused about it too – and for good reason, as you’ll find out below!

What’s more, quite a lot of that theory (which is often dressed up with impressive sounding equations … about standard deviations and efficient frontiers to name but two) is really just silly mumbo jumbo!

So, let’s cut out the complexity – and look at what you need to know.

The mumbo jumbo

You need to be especially aware of this when it comes to investing because, sadly, there’s way too much of it around. And, I’d suggest that you take particular care if you see a statement like this:

‘Our investment process is based on a Nobel Prize winning theory’

Why?

Because, when it comes to the theories of how stock markets work, the economics profession has given Nobel prizes to two people with diametrically opposed views.

Yes, I know that sounds incredible but it’s true 🙂

So, you need to know which Nobel Prize winner your wealth manager follows – to decide on the value of that!

If that’s of interest, you might want to learn:

How two Nobel Prize winners can hold opposing views

How to check if your adviser really understands risk and

Why you need to think one step beyond ‘efficient frontiers’

Have you chosen your box?

Now, I’m assuming that you’ve already chosen your investment box (aka wrapper) for your money.

This might be a pension plan, an ISA, a simple investment fund or something else. And getting the right boxes for your savings and investments is critically important.

So, whether you’ve done that already or you’re reviewing what boxes might be right for you now, it makes sense to use a solid process … and I’ll offer you one of those very soon.

Be sure to get notified about that.

Money Box under the bedKeep a close eye on charges

Of course, you’ll also need to keep a close eye on the total level of charges you pay (for your investment box, for the funds inside it and for any advice that surrounds it) because these charges can (in some cases) add up to so much as to make the risk of investing a complete waste of time.

And, if you’re not already familiar with this important issue – you can find out more here and here

Just focus on four factors

But once you’ve settled on a fair value investment or pension wrapper (or direct investment) and before you get into the grisly detail of fund choice, there are broadly only four factors that should drive your investment risk exposure.

You need to consider:

  1. Your general attitude to investment risk (this is sometimes called risk tolerance)
  2. Your need for investment risk (on each of your financial goals)
  3. Your capacity for investment risk (on each of your goals) and
  4. Whether your chosen investment assets (Shares, Bonds, Property for example) are especially expensive or cheap compared to their long-term averages.

And you should pay close attention to all four points.

If you use a financial adviser/wealth manager (and I’d encourage most people to do so) then make sure that your adviser is carefully considering all four of these points too.

Sadly, not enough of them do.

And be doubly sure to focus on the third point in that list – your capacity for investment risk …

… because this can often reveal a need to take a very different investment approach for your different financial life goals.

For example, if you have a lump sum of money that you’ll need in 5 to 7 years’ time, you might need to invest it in a very different (less aggressive) way to any regular savings you’re putting into your pension over 20 or 30 years.

So, taking account of your capacity for risk can help you financially in two ways:

  1. By protecting your capital on shorter-term and lump sum investments and
  2. By persuading you it might be OK to go for higher returns on your longer-term, regular investments. And thus reduce the cost of achieving your goals 🙂

You can learn more on all these issues in my book, ‘Who misleads you about money?’ …

… and for updates on these articles – and the other ideas …

… just sign up to my newsletter here.

All the best for now

Paul

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