What kind of risks will you take to succeed?
Part 4 - How to Become an Investorgetic®. The secret to becoming a Millionaire Series
Are you a risk taker?
I’m not talking about whether you’ve gone skydiving or bungee jumping. I’m talking about your attitudes towards financial risk.
If you want to create a solid financial strategy, you need to invest your money. But investing is a risk. It is impossible to know with absolute certainty that your investments will succeed. However, there is a world of difference between taking a gamble and taking a considered, calculated risk focused on realistic financial returns.
The investments you undertake must fit with the level of risk you are comfortable with. Understanding your risk profile is crucial to this. Your risk profile helps you determine how you should invest your money for maximum gain. It encapsulates your attitude towards debt, your tolerance of market volatility, your concerns about loss of capital and your investment comfort level.
Not all investments work for all people. If you are risk averse yet dive headfirst into a volatile market, chances are your investment will fail. If you can make investment choices based on your core money values and attitudes, you will have more chance of achieving investment success – and financial liberation.
What determines your risk profile?
Your risk profile is shaped by numerous factors, including:
· Your investment experience.
· Your ability to understand financial matters.
· Your investment time horizon, eg. 10 years, 20 years or 30+ years.
· The importance you place on understanding what you are investing in.
· Your tolerance level towards investment loss and the timeframe in which you can tolerate the loss.
· The level of cash you have available to top up investment losses or unexpected expenses.
· Your income and tax rate.
· Your level of personal debt, eg. mortgage and credit card debt.
· Your desired retirement income.
The “pillow test” is a tactic I regularly use with my clients. I ask them: “Would you sleep easy at night if you invested X amount and borrowed X amount?” Their answer helps determine their risk profile. You don’t want to spend night after sleepless night agonising over your investment decisions, no matter how high the potential returns.
Where are you on the risk profile spectrum?
There are five areas in the risk profile spectrum: Conservative, Balanced, Progressive, Assertive and Aggressive.
1. Conservative: A conservative investor is afraid of losses. They have the most basic understanding of investment markets. They focus on protecting their capital, seek moderate returns and are prepared to only take a very low level of financial risk.
2. Balanced: A balanced investor is also a low-level risk taker, yet is prepared to establish a more diversified investment portfolio. They have a reasonable understanding of investment markets. While they are wary of potential losses, their focus is more on possible gains.
3. Progressive: This type of investor is focused on opportunity and quality investments. They are more accepting of market fluctuations and can accept higher levels of investment risks. They have a long-term investment time horizon and seek to achieve a moderate rate of growth on the capital they invest.
4. Assertive: An assertive investor is focused on capital growth and accumulating wealth quickly. They have a solid understanding of all major investment markets and get a thrill out of taking financial risk. They have a long-term investment time horizon and understand that higher the level of risk, the higher the potential gains.
5. Aggressive: An aggressive investor has a superior understanding of investment markets. They know that high volatility and high risk are central to high-value investments. They predominantly invest in shares, staying focused on possible gains. They think for the long term and expect high-level returns.
So, where do you sit in the risk profile spectrum? Are you preoccupied with losses or do the potential gains override your concerns?
Don’t worry if you fall into the conservative category. You don’t need to be an aggressive investor to experience favourable returns. But it’s imperative you seek expert financial advice to make the best investment choices for you.
Next week in the Investorgetic® series, we will discuss how you can use the tax system to your financial advantage.