Risk vs. Rewards: How to balance your risk tolerance with your investment strategies

When it comes to building your wealth, investing can be invaluable.

A comprehensive investment strategy can see your wealth grow far beyond the potential of a standard savings account. Over time, your wealth will accumulate through interest, dividends and capital appreciation. This can act as an income stream to see you through some of life’s biggest milestones.

However, risk is an inevitability that comes with any investment. With that in mind, Investment Director, Oliver Stone explains the importance balancing your risk profile with your investment strategy.

What is risk tolerance?

As an investor, there will be a threshold of risk you’re willing to take. Risk tolerance is the benchmark of how comfortable you are with the potential of making a loss, as well as your tolerance of market volatility.

There is a whole array of different factors which can influence your risk tolerance. Your past investment experience, your financial ambitions and even your personality will all impact your risk tolerance.

Having a clear understanding of your level of risk tolerance is vital before you invest. A good starting point is to ask yourself the following questions:

• As a person, are you someone who embraces risks for the chance of a greater reward?
• Would you feel worried as and when the market dips?
• How would you feel if your investments decrease in value?
• How comfortable are you with the volatility of the market in general?

What is risk capacity?

Risk capacity takes your emotions out of the equation. Instead, it is an indicator of you much of a risk you can viably afford to take.

Risk capacity is focused on practicalities, rather than your emotions, taking your stage of life, financial situation and investment timeframe into account. Your savings, income and liabilities will all be considered.

If you’re a high earner, with a steady income and still have decades before retirement, you’re likely to have a higher risk capacity than someone who is nearing retirement and can’t afford substantial losses.

How to assess your risk tolerance and capacity

If you are looking to start investing, aligning your risk tolerance and capacity is absolutely critical.

It ensures that you aren’t taking on too much unviable risk which could impact your finances or create worry. Equally, it can also ensure that you aren’t being too conversative in your investments, which would impede the growth of your wealth.

Here are some practical tips to use when assessing your attitude toward risk:

• Self-assessment: It’s useful to reflect on how you felt when facing financial losses in times gone by. With this in mind, think about your financial goals and how much volatility you are willing to face to achieve them.
• Financial review: What does your current financial situation look like? Delve into your income and savings, but also look at the debts you may have and the potential for future needs. This will help to clarify how much loss you can realistically afford without impacting your financial security.
• Investment time horizon: If you are looking to invest over a longer time frame, you will generally be able to take on more risk. This is because you will have a longer time to recover from any losses.

How to choose your investments

Once you have a clear understanding of your risk tolerance and capacity, it is important to speak to an independent financial adviser. They will be able to offer you whole of market advice on investment options.

The options you could be looking at, depending on your risk tolerance and capacity, could include:

• High-risk tolerance and capacity: a portfolio mostly focused on higher risk assets, which will predominantly involve equities. Within an equity allocation there could be a greater emphasis placed on potentially higher risk/reward areas such as smaller companies and emerging markets.
• Moderate risk tolerance and capacity: a more balanced portfolio comprising a blend of higher and lower risk assets. This will typically see equities and fixed income securities held in appropriate proportions, which serves to dampen volatility. There may also be less of a focus on higher risk/reward areas within the equity allocation.
• Low-risk tolerance and capacity: a portfolio mostly focused on lower risk securities, which will predominantly involve bonds. This could include government and corporate bonds, and while some equities may still be held as appropriate, there may be an emphasis on lower volatility segments of the market to reduce volatility.

Ready to take control of your financial future?

Our team of IFAs are here to help curate an investment strategy which is tailored to you. They will be able to delve into your risk tolerance with a specific questionnaire. Providing you with insights into comfort levels when it comes to risk.

From here, they will listen to your goals and your plans, and create a bespoke investment strategy which is aligned to your profile. If you would like to discuss your investment plans in more detail, please feel free to get in touch.

THIS ARTICLE DOES NOT CONSTITUTE TAX, LEGAL OR FINANCIAL ADVICE AND SHOULD NOT BE RELIED UPON AS SUCH. TAX TREATMENT DEPENDS ON THE INDIVIDUAL CIRCUMSTANCES OF EACH CLIENT AND MAY BE SUBJECT TO CHANGE IN THE FUTURE. FOR GUIDANCE, SEEK PROFESSIONAL ADVICE.

THE VALUE OF YOUR INVESTMENTS CAN GO DOWN AS WELL AS UP, AND YOU MAY GET BACK LESS THAN YOU INVESTED.