What is risk?
Risk is the possibility of a loss of capital during the term of an investment.
Risk is the degree to which investments can go up and down over time; therefore, risk and return are always linked.
Time is an important factor when thinking about risks associated with investments. The more time you have the more risk you can take. Time helps riding out price movements, leading to potentially higher eventual returns.
Diversification across asset classes, market sectors and investments is the key to minimising the risk (or loss) across a portfolio.
Types of risk
- Interest rate risk – changes to interest rates can reduce your returns or cause you to lose money
- Liquidity risk – you may not be able to access your money as quickly as you need to, without suffering a fall in value
- Inflation risk – the real purchasing power of your invested funds may not keep pace with inflation
- Currency risk – investments in assets located in other countries may rise or fall in value due to the relative value of the Australian currency
- Market risk – movements in the market mean the value of your investment can go down as well as up – and sometimes suddenly
- Mismatch risk – the chosen investment may not be suitable for your needs, goals and circumstances
- Timing risk – trying to time entry to, and exit from markets can expose you to potentially greater short-term volatility
- Risk of not diversifying or concentration risk – if you put all of your capital into one market, a fall in that market will adversely affect all of your capital
- Legislative risk – your investment strategies or products could be affected by changes in current laws and regulations
- Value risk – you may pay too much for an investment or sell it too cheaply
Risk Profile/Risk Tolerance
Your risk profile is your attitude to investing in different types of investments and markets, and how comfortable or uncomfortable you are with the value of your investments moving up and down. It is about asking yourself:
How comfortable are you with safe investments? How comfortable are you with risky investments? How much risk are you willing to take? Do you need income and/or growth from your portfolio?
Your investment timeframe is relevant to determining your risk profile. The types of investments you should hold will be determined by whether you are investing for the short, medium or long term. Therefore, goals and objectives need to be considered in these decisions.
Your age, health and capacity to recover from financial loss are other factors that affect your risk profile.
Once your risk profile is established, we determine an appropriate asset allocation for your portfolio. We use this to manage your portfolio risk and volatility, and the asset allocation will be the primary determinant of your long-term returns.
The more conservative and sensitive you are to loss, the higher the allocation to defensive investments (cash and fixed interest).
The more comfortable you are with risk, the higher the allocation to growth assets (shares and property).
The risk return trade-off is relationship between the level of risk of an investment and the expected level of return that it can earn.
Discussions about risk required, capacity and tolerance
Your agreed risk profile is determined after discussing your indicated risk profile (the outcome of the questionnaire) and considering the following:
- Risk required:
- What is the return you are seeking to achieve on your investments based on your stated goals and objectives?
- Would you be able to achieve your goals and objectives with your ‘indicated’ risk profile or even a more conservative approach, or will additional risk be required?
- Risk capacity:
- How much investment loss would you be able to afford without jeopardising your goals and objectives?
- Do you have enough assets and/or income?
- Is the ‘indicated’ risk profile appropriate based your stated investment horizon?
- Risk tolerance is the level of risk a client is comfortable taking, or the degree of uncertainty they are able to handle.
Once this is all discussed, your risk profile is determined and agreement on the chosen risk profile will be sought.