Balancing risk & reward as an investor
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
Many people are attracted to the idea of investing. After all, the returns can be higher than the interest gained on cash savings. Yet the downside is the potential risk involved. It is possible that the value of your investment falls below your initial purchase price.
How can investors approach this balance of risk versus reward? Below, our Grantham financial planners show how this can be achieved by working through a set of criteria to ascertain your risk profile (ideally with a professional).
We hope these insights are helpful to you. To discuss your financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
Determine your goal(s)
As a general rule, the potential for higher returns from capital growth (e.g. rising share prices) goes up in line with risk. For example, a large, established company – listed on a recognised stock exchange – may have little space in its marketplace to grow. However, its share price is likely to be more stable than a young company which is more vulnerable to market/economic shocks. Conversely, an early-stage business may have more “runway” ahead to grow its share price for investors.
As such, a key part of the risk-reward balancing process is for the investor to determine their overall investment goals. In particular, are they more focused on wealth growth or wealth preservation? The former may incline them towards “lower risk” opportunities; the latter more towards “higher risk” ones.
Another important consideration is to ask yourself what you want your portfolio to do. Namely, do you want to focus on capital appreciation? If so, then receiving regular dividends may not matter as much to you as companies re-investing their profits back into growing their business.
By contrast, do you want to draw an income from your investments? If so, then dividends may be more important to your strategy. This may incline you more towards stocks with a history of stable share prices and high dividend payments.
Such companies are less likely to have the same growth potential in share price as “growth-focused stocks”. This is because they distribute profits to shareholders rather than ploughing them back into their businesses to fuel growth.
Establish your time horizon
Linked closely to the above is your investment “horizon” – i.e. the length of time you plan to invest for. As a broad principle, the longer the time until you need the money, the more risks an investor can sometimes justify taking.
This is because there is more time for the investor’s portfolio to recover from – and surpass – the market instability and crashes which may occur throughout the investment timeline. Whilst “shocks” could transpire along the way, the investor can still aim for an overall growth trend.
By contrast, if an investor needs the funds soon, then there is less time for the portfolio to recover if there is a market crash. Therefore, they may prefer to lean their investments more towards “safer” assets such as UK government bonds (gilts).
Diversify your portfolio
With your risk-reward profile balance starting to become clearer, it is important to consider how your portfolio will feature a mixture of investments. After all, investing in just one company, market or asset class can leave your portfolio vulnerable during a market crash in that area.
Instead, by “spreading out” investments across different companies, sectors and countries, an investor can mitigate the risks involved with individual opportunities. For instance, if an investor holds 100 investments and 10 of them fall, the remaining 90 can help keep the portfolio afloat.
An investor can buttress their portfolio not just by investing within an asset class (e.g. stocks/shares) – but also across asset classes. Commonly, this involves combining a mixture of equities, bonds, property and cash investments.
Determine your appetite
After all these technical steps, your portfolio will still experience fluctuations. It is important to be honest with yourself about how comfortable you are with different levels of market volatility – and your overall attitude towards risk.
Here, a financial adviser can help you ask yourself the necessary (sometimes uncomfortable!) questions needed to ascertain your investor profile. A good starting point is to ask yourself: “How would I feel, and react, if my portfolio suddenly crashed by 25% tomorrow morning?”
If you are confident that you would be patient in waiting for the market to recover, continuing with your investment strategy, then this may indicate a higher risk tolerance (e.g. leaning you towards “growth” investments, like early-stage equities).
By contrast, if you know that you would face a strong temptation to pull out of the market (panic-selling your investments) then this may indicate that you need a more “cautious” approach to your asset allocation. Here, you may prefer more “stable” assets like gilts.
There is no “right” or “wrong” investor profile. There are just different people, with different needs and goals. The key thing is to be true to yourself and to your long-term strategy.
Invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
