10 Risks You Need To Consider To Protect & Grow Your Wealth
27 Oct 2011 | 3 min
read
Written by Kate McCallum, Multiforte
When we talk to clients about risk, we focus on the concept of risk as the possibility that they will not be able to meet their financial objectives. Think of this as your "destination risk".
We also talk about volatility, which is the extent of variation in return, and a hot topic right now. Think of this as your "journey risk" - that is, how smooth or bumpy the ride.
The strange thing is, most investors worry more about volatility than whether they will achieve their goals - often not realising how much risk they have taken on until something goes wrong. By then, it's often too late.
So, here we share 10 risks to consider and tips help you maximise your assets and protect your lifestyle.
- Consider your risk capacity. This is your ability to withstand downside risk based on your situation and objectives, and should be assessed alongside the more commonly considered risk tolerance - which is the emotional willingness to tolerate downside risk. A good investment strategy should make good investment sense from a risk capacity standpoint and also have a pattern of returns that will not lead you to abandon your strategy because your risk tolerance is insufficient, particularly during market extremes.
In our experience, most people think about themselves as a particular type of investor - "I'm a growth investor" or "I'm a balanced investor". Yet very few think about their willingness to risk losing substantial sums of money in dollar terms. We believe that a "balanced" investor should be able to tolerate a one in 20 year loss of around 20% of their money. On a $500,000 investment, that's a loss of $100,000. Would you feel comfortable with that?
- Define your time frame for each of your goals. Then work out how your finances will support them. You may have a separate portfolio for each major goal. For a short time frame, it makes sense to have a portfolio with more interest-generating investments for stability. For a long time horizon, inflation is usually a bigger risk than volatility, and it makes sense for a portfolio to have a high proportion of equity investments to maintain and grow purchasing power.
- Beware inflation risk. This is usually considered in relation to younger investors. It is also critical if you are near to or commencing retirement - in fact, inflation may still be a bigger risk than volatility. Your money may need to last for a lot more than 20 years - which is a long time frame and may require an equity-oriented strategy.
- Avoid taking large risks at any age with a substantial portion of assets. And this includes allocating all of your available assets to investment property. It also includes taking large risks with most of your superannuation monies.
- Diversify. Diversification can reduce risk without reducing expected return. A 100% bond portfolio or a 100% equities or property portfolio makes sense for no one. Right now, in the wake of the recent market correction, we are seeing many poorly diversified portfolios. As investors have sought refuge in cash, they have ended up with too much in shares and too much in cash with little in between. This results in a portfolio stretched between two extremes - with equities contributing high volatility and cash delivering low returns.
- Evaluate your employer shares. Most people know there is a risk in putting all of your hard-earned money into a single share. Yet plenty of people do it inadvertently because they hold a lot of money in their employer's share plan.
- Think about when you buy (or sell) equities. Buying shares at high price/earnings ratios is a poor decision. Yet, this is often when most people feel comfortable buying more shares (and not selling). On the other hand, buying at lower price/earnings ratios will be more fruitful. However, most investors find this scary. Even though logic tells us that even though times may look challenging, this is often when you'll find more favorable opportunities.
- Regularly rebalance to an ideal asset allocation. A 'set and forget' asset allocation can lead to overexposure to risky assets in rising markets, which when markets fall, results in greater losses. Regularly rebalancing your super and investments can improve returns without creating additional risk.
- If you are a young investor, maximise and protect your human capital. For most 25-year-olds, the value of human capital (the present value of future earnings) is near a lifetime maximum. This means developing your job skills, saving aggressively as income rises, and investing aggressively. Of course, most young adults fail miserably on the third point.
What's more, few people in their 20s and 30s protect their human capital - they don't consider life's "what ifs". Research tells us that most young Australians think that illness, injury or death won't happen to them, and even if it does, they'll be okay. Ask yourself this: What if I became seriously ill? What if one of my children needed long term medical care? What if my spouse passed away? We all know that injury, illness and death do happen. If things went pear-shaped for you, would you have the right insurances and risk management in place to maintain your finances and your lifestyle?
- If you are nearing retirement, maximise your financial capital. For most at this stage, wealth is almost entirely financial. Sadly, this holds as true for those who failed to plan ahead as for those who have an ample nest egg. Preservation of financial wealth is critically important at this stage. The best financial advice for those preparing for retirement is to take risk off the table and pay careful attention to inflation risk not just volatility.
tags:
News
categories:
News