Understanding Investments

Attitude to Risk

Attitude to risk is a highly personal thing.

Some people are happier with a much higher level of risk because of the potential reward. Other people prefer to keep the risk low, recognizing that their rewards will also be lower.

Attitude to risk can also change over time.

Sometimes you may be happier with a higher level of risk because you have longer to recoup the potential losses if something goes wrong. For example, if you invest in a pension fund in your 20s, you may be happier for the fund manager to take more risks in managing the money than when you are in your 50s, and expect to want the money within the next 10 years.

There are two keys to safe and confident investing.

Understand your personal attitude to risk—and ensure that any independent financial adviser or fund managers that you employ also understand your attitude.

Manage your financial risk across your portfolio. In other words, don’t think about risk so much in terms of each individual investment, as across your portfolio (collection of investments) as a whole.

It does NOT remove risk entirely.

The high risk products are still very risky. It’s just that there aren’t very many of them included in any package or ‘wrapper’, so the loss to any individual investor is limited.

This was the problem with the US sub-prime mortgage market a few years back. Banks had developed a process to lend to people who were considered at high risk of default by ‘wrapping’ these mortgages up into ‘packages’ with less risky investments. Overall, the package looked reasonable, and the banks were able to raise funds against them. However, once large numbers of people started to default on their mortgages, the problem became very apparent, and the value of these investments dropped dramatically.

Whatever route you choose for investing, get advice first.

Before you invest, it is a good idea to get advice from a good independent financial adviser.

They will be able to help you select the right classes of assets, or recommend one or more suitable funds that will match your investment objectives and attitude to risk.

INVESTMENT ISSUES TO CONSIDER

1. Learn as much as you can about the investment from the prospectus, financial magazines, and the plan administrator.
2. Remember that past performance is not a guarantee of future performance.
3. Consider how long you plan to keep your money in the investment. If you invest over time, you are more able to ride out the ups and downs of the stock market.
4. Do not put all your eggs in one basket. You should have a mix of investment products that reflect your needs for return, safety, and long-term savings.
5. You ideal composition of investment products will shift over time, so re-evaluate what you have from time to time.
6. Determine how much risk you are willing to tolerate. Remember, there is a tradeoff between risk and return.