Would you worry if your portfolio was down this quarter? Or would you just stay calm and trust it to rise again?
Our tolerance for risk is a very personal thing, so there’s often no right or wrong answer. You could be a multimillionaire, but still fret over a small drop in value. Understanding more about your ‘risk profile’ tells us a lot about what you can expect from your future returns.
Nobody wants to have sleepless nights over their money. That’s why, when we meet a new client, getting to know how they feel about risk is such an important part of our initial fact find.
Last month we looked at the spectre of inflation. When you’re looking for higher returns than cash, investing in something like the stock market is one of the best ways to do this over longer time periods.
We can see that in the solutions we offer. In the chart below, we’ve looked at mandates invested in equities, property, and fixed income assets over the last 20 years, each with progressively greater levels of risk. We’ve compared annualised returns and volatility, a measure of how much prices have gone up and down in that time – the higher the volatility the more investment risk involved.
What does it show? Over that period, the ‘riskier’ investments saw the strongest performance and comfortably beat inflation.
Source: Parmenion ValidPath Investment Solution risk-graded portfolios for 20-year period ending 31 December 2020. Investment mandates 1-11 contain varying weightings of asset groups: Ultra Short Fixed Interest, Fixed Interest, Property, UK Equity Growth Developed Markets Equity and Emerging Markets. Inflation data is average yearly Consumer Price Index data from Office for National Statistics over 20 years.
But putting your money in at point A doesn’t guarantee what you’ll get out at point B. We’ve had record highs in global stock markets, but also notable slumps, the global financial crisis in 2007/8 and the dip following the start of the pandemic.
From a long-term investing perspective, it’s important not to get panicky. The main thing is to remain invested – over time, the ‘ups’ greatly outweigh the ‘downs. Whether your return is 5% or 5.5%, isn’t necessarily going to make a massive difference to the final outcome.
Knowing more about how much risk you’re prepared to take will help set your mind at ease.
So what’s right for you? We can break down your risk profile into four parts:
Your investment timeline. A longer time horizon, such as saving for retirement, generally means you can accept greater degrees of fluctuations in the market, than if you were more focused on the short term.
Your knowledge and experience. Many investors have the experience of many years of paying into a pension, but lack the market knowledge. That’s why it’s often a good idea to seek expert advice.
Your risk tolerance. This is very individual and hard to quantify. Safe to say that waking up at 3am panicking your portfolio has lost £500 isn’t where you want to be. How would a 20% move in the market make you feel?
Your capacity for loss. This last one is critical. It isn’t just how you feel about risk, it’s the real impact a drop in value would have on your ability to sustain your lifestyle and meet your long-term financial objectives. How would it affect everyday expenditure, or bigger-ticket items, such as holidays or family occasions?
It’s when these components come together that we’re able to get into the important stuff, like cashflow planning. This will give us an overall view on where you’re going to need your money and when. Are you going to have to spend it all to avoid IHT? We can map out what would happen in hypothetical scenarios, such as a market crash, or if you suddenly need to find additional funds to cover an unforeseen event.
You’ll be hearing much more about your risk profile from us this year. We’ve introduced a new questionnaire that will enable us to get an even better picture about what’s right for you.
Our risk profile looks at where you sit on the spectrum. Moving from low risk, to moderate, to adventurous. We match that up with whether you’re looking at short, medium, or long-term investment timeline.
And it’s important to keep checking in. We update the risk profile every three years. When one of our clients came to us not so long ago, they were unaware that the default fund for their workplace scheme was a relatively high-risk strategy. At age 60, they decided now was the time to switch to a different option.
We know that for some this might feel like a chore – after all, if we’re the experts, why can’t we just make the decisions! But getting your risk profile right is vital. Thinking carefully about your attitude to risk and your ideal investment timeline, could be the difference between a sleepless night and peace of mind that you’re on the right path.
The value of investments may go down as well as up and you may get back less than you invest.
Past performance is not a reliable indicator of future performance.
