Thinking of investing your money, but don’t know where to start? Before you pick up that stock or mutual fund – Let’s figure out what type of investor you are and what style of portfolio would suit you.
While some people can easily handle the equivalent of financial skydiving… others like to dip their feet into the investment pool with many lifebuoys. Based on your attitude towards risk you can either opt for a conservative, balanced or aggressive portfolio.
The risk to return trade-off
In investments, ‘risk’ refers to the chance that the return you get at the end will be different from what you expected. It means that there is a possibility of losing some, or even all, of your originally invested sum of money. Typically, people believe that a low level of risk means low returns and higher risk equals greater return. However, there are never any guarantees – Just as higher risk could mean higher returns, it also means higher potential losses. The risk to return trade-off is the balance between the desire for the lowest possible risk and the highest possible return.
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What’s my risk appetite?
No one likes to lose money. However some risk is necessary to see returns on your investment. How much uncertainty can you handle?
Risk tolerance is different for each individual – Not only does it depend on the person’s attitude, but also on other factors such as: your age, number of dependents, job stability, future goals, current financial status and investment time horizon.
Apply the ability-to-sleep-at-night test to yourself. Are you patient? Do you get nervous when times are tough? Do you like to take chances? Your answers will tell you how much risk you can handle. You can use this calculator to help you understand what kind of risk you are able to take – CalcXML ‘What is my risk tolerance?’ questionnaire.
Pick your investment style
Now that you have determined your risk tolerance, you can create an investment plan. Here are some portfolio types to consider:
- The Aggressive Portfolio – 90 to 100% of your money is channeled into high risk/high reward asset classes such as stocks or property. Typically, these assets will have a high sensitivity to the overall market. In stocks, companies that are in the early stages of development could be included. With this type of portfolio, while short-term fluctuations shall be experienced very often, long term growth may be greater than others.
- The Balanced Portfolio – The investment mix split would be such that the portfolio is exposed to a medium risk level. 35 to 65% could be channeled into stocks and property. The remaining proportion in lower risk assets such as cash, bank deposits, bonds, and other fixed-interest investments.
- The Conservative Portfolio – Bank deposits and fixed-interest investments such as bonds will form the majority of your investments. Only about 10 to 30% will be put into higher risk assets. This is suitable for uncertainty-averse investors who want their balance to remain relatively stable.
When you choose a portfolio, keep in mind what you’re trying to accomplish: be it creating a retirement fund, buying a home, starting a business, or saving up for your child’s education. How much do you need from your investments to achieve your goals? Your answers to these questions will help shape your investment plan.