Understanding Your Investment Risk Profile
Helping you make confident decisions about your financial future by understanding the three aspects of your risk profile: the level of risk you’re comfortable with, what risk you can afford to take, and what risks you need to take to reach your goals.
Why Your Risk Profile Matters
We aim to design a wealth management strategy and investment portfolio that meets your long-term goals and makes the journey along the way as comfortable as possible.
For us to make appropriate investment recommendations for you, it’s important we understand your “risk profile”, which involves figuring out how much risk you’re willing to take, how much risk you need to take to achieve your goals, and how much risk you can afford to take.
Everyone is different and getting to the right answer on how much risk we should build into your portfolio is a balance between science and art – and communicating. To help you think about those questions, we have developed a simple guide about what “risk” actually means, financial markets and different types of investments.
What is risk?
Longevity vs Short-Term Risk
Risk means different things to different people, but for most of us, the main concern is outliving our money, otherwise known as longevity risk.
That’s a long-term risk. There are also short-term risks, such as financial market corrections, like we saw in the Global Financial Crisis of 2008, or the COVID crash in 2020, where your resolve to stick to an investment plan can be sorely tested.
Other short-term risks can come from geopolitical events, natural disasters or changes in interest rates by central banks.
Volatility and Market Events
There is almost no end to the range and nature of things that can cause the value of your investments to fluctuate.
An important part of investing is understanding that if you would like to generate a return on your money that is above cash rates, then you will need to take some risk, but there is a broad spectrum, which is partly what this overview is about.
You Can’t Predict the Future
You also need to accept that nobody can accurately and consistently predict the future, but you will be bombarded by people claiming they can. Learning to ignore the noise around you is one way of dealing with the inevitable risks that come with investing.
Having an understanding of what you’re investing in is another.
different strokes for different folks
You might be in the fortunate position that you’ve got more than enough money to support the lifestyle you’d like to lead in retirement.
Does that mean you invest in a very conservative portfolio, which is likely to deliver relatively low returns, because you feel you’ll sleep better at night?
Or does it mean you feel comfortable targeting a high return because you’re confident you’ve got a good enough buffer to see you through any downturns?
It’s part of our job to work with you to figure out what is a suitable risk profile for you and your particular circumstances. We do that by firstly helping you understand what risk might mean to you, and then by talking to you and perhaps running through questions designed to gain insight into your attitude to risk and money.
While it’s important to land on an appropriate risk profile, because it shapes the kind of portfolio we recommend, it’s also important to appreciate it can change over time. The risk you’re prepared to take with your money when you’re in your 40s is very likely to be different to when you retire.
THE RANGE OF INVESTABLE ASSETS
The range of assets you can invest in is almost endless, and each one sits somewhere along the risk-reward scale. As a general rule, the more risk you take the more reward you expect in return.
When you look at different investable assets, it’s important to think about what risk might mean to you. For some, it might be the risk of not being able to access your money when you want it, or perhaps it’s the risk that the return won’t be sufficient to meet your long-term needs.
When people talk about risk in the context of an investment portfolio, they usually mean the volatility in an asset’s price or value, in other words, the possibility of losing some or all of your money.
Cash
The safest asset is cash, because it has zero volatility. The prices of things you might want to buy may change, but the unit value, the dollar, doesn’t.
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If you keep your cash under the mattress, that introduces some security risk, but when it’s held in a bank, whether it’s in a savings account or a term deposit, you should feel very safe, especially in Australia where the government guarantees cash balances up to $250,000.
However, the downside is that it’s unusual to get a bank interest rate that is much above the rate of inflation, which means over the long run, your money loses its purchasing power and you end up going slowly backwards.
Property
Almost everyone is familiar with property because a lot of Australians own a home, and a lot of people also own an investment property.
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There are also different ways to invest in property. You can buy it yourself, or invest through a syndicate with a professional fund manager, or buy listed property trusts on the stock exchange.
One feature of property is that a lot of people see it as less risky, because the price doesn’t fluctuate as much as share prices. However, the main reason for that is liquidity, which refers to how quickly you can buy or sell an asset.
Property is illiquid, meaning if you want to sell a property, by the time you’ve advertised it and gone through an auction or other type of sale to find a willing buyer, it could be months or even up to a year, before you get your money.
That means you won’t get a proper valuation on your property until you’ve sold it, so you don’t really know accurately what it’s worth on a day-to-day basis. By contrast, shares are valued every business day on the stock exchange, so you know exactly what they’re worth minute by minute.
That kind of liquidity can be a blessing and a curse: you can get your money much more quickly by selling shares, but it also makes it easier to panic and sell them when you really shouldn’t.
For a more detailed discussion of investing in shares vs property, see our blog article.
Bonds
There are other investments that will pay you interest, such as bonds, which are a form of debt instrument. They are effectively an IOU where the issuer of the bond promises to pay you back your original investment at a certain point in the future, and in the meantime will pay you an interest rate, which will vary depending on how safe the borrower is.
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Bonds can be issued by a government, like the Australian federal government or one of the state governments. Because the federal government is all but guaranteed to repay the amount invested, it is very low risk and the interest rate you receive reflects that, so it will be relatively low.
Companies can also issue bonds, and they can vary enormously in how risky they are. Buying a bond issued by the Commonwealth Bank is a very different proposition than buying one issued by a much smaller company, so again, the interest rate you receive will be lower.
The bond market is enormous and truly global. You can invest in bonds from all over the world that run the whole gamut from super safe to high risk.
Something to remember with bonds is that you don’t have to hold them to maturity, but the price you get if you sell before then will depend on a bunch of different factors. Just like shares, you might be able to sell them for a higher price than you bought them for, or they can trade at a lower price. The only way to avoid that volatility is to resign yourself to holding the bond to maturity.
Private assets
If an asset is not traded on a public market, like a stock exchange, then it’s considered to be a private asset. The range of private assets is enormous, much bigger than publicly traded assets, and can include everything from companies, to properties, to infrastructure assets, to loans, to stamp collections.
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Investing in private assets has been around for as long as people have been investing, but it became a more recognised asset class in the 1980s, when big institutional investors started allocating funds to it.
It’s only since around 2010 that individual investors have been able to invest in private assets, and more recently the number of funds offering access has increased significantly.
There are plenty of advantages to investing in private assets, such as returns that have historically been better than those available on public markets and lower volatility, however, like property, that low volatility largely comes because of reduced liquidity.
Broadly speaking, there are three kinds of private assets that would be candidates for an individual’s portfolio: private equity, private infrastructure and private credit.
Private equity generally refers to investing in private companies, which can range from startups to established enterprises, and can be based all over the world.
Private infrastructure can include investing in assets that are essential to an economy, like airports, roads, or power generation.
Private credit is where you invest in loans, which will be secured against some kind of asset.
You can read our blog article on private equity here, and one about private credit here.
Shares
While pretty much everyone knows what shares and share markets are, not everyone feels like they understand them very well or have much experience in investing in them. Indeed, there are plenty of potential investors who are worried about investing in shares because they see them as too risky and maybe don’t know where to start.
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When you buy a share, you are literally buying part of a company. For a small company you could be one of thousands of shareholders, and for a big company, like a BHP, you would be one of millions, many of which will be large institutions, like superannuation funds.
Any company that’s listed on a stock exchange, which enables investors to buy and sell their shares, must adhere to a strict set of “insider trading” rules around how they disclose information, because to keep things fair, it’s important every investor can access the same information as any other one.
Because shares form a large part of the portfolios we normally recommend for clients, we thought it worthwhile to take a bit of a deeper dive in the next section.
shares – an introduction
Learn about volatility, global diversification, and how we build portfolios that balance risk and return.