Investment basics - risk profiles

What are risk profiles? When deciding the mix of assets you choose to invest in, your choice should match your personal attitude or tolerance to possibly losing money in the short term, with the intention of making money in the longer term. If you have a match, then you should feel comfortable with your investment selection and comfortable with how they behave and respond to the market. Your investment selection should pass what I call the pillow test—can you sleep at night? If you find yourself worrying about how the market goes up and down or that your investment return is so low, then you may not have the right mix of assets in your investment portfolio and might want to consider reviewing. So as an investor, how do you know what your area of comfort is? There is a tool called a ‘risk profile’ that financial planners use to work out an investor’s attitude toward risk. It’s a personality test that’s a requirement of financial plans. Firstly, it helps investors be confident in their investment choices. Why do you have this managed fund instead of that one? Or more in the bank than you have in shares? Because it all matches with your risk profile. Secondly, it proves that you are the focus of your investment strategy. You have invested based on your tolerances and comfort factors. The strategy isn’t based on your planner’s preferences or your neighbour’s ideas. It is only based on your personal attitudes to investing. The purpose of a risk profile is to find out your risk tolerances. If you feel that protecting your capital is the most important thing—more important than the income you get—then you don’t have much of a tolerance for risk and would be considered a conservative investor. If you’re the opposite and can handle watching your capital balance, go up and down because you’re confident that you’ll get those big returns, then you’d be considered an aggressive investor. Just be aware of the terms used. There’s no agreed definition of terms like ‘conservative’, ‘balanced’ or ‘aggressive’. It’s also important that you don’t think of your investments based on your understanding of that term because your idea of ‘balanced’ may not be the same as a balanced fund. Always focus on the mix of assets you’ve invested in. Look at the breakup of cash, property and shares. You can find this in the investment’s Product Disclosure Statements. The Product Disclosure Statement (or PDS) is a document provided by investment companies that explains the ‘nuts and bolts’ of what you’re about to buy. It includes all of the costs as well as a breakdown of the asset mix. This is the information you need to compare with your risk profile. If you don’t have to have a financial planner to find out your risk profile, there are a few versions of the personality test that you can find online. Be aware that they aren’t all the same quality, and they are almost all connected to a financial provider, like a bank or a financial planning firm. Be aware that after doing their risk profile, they will often ask if you want to make an appointment to speak to one of their professionals. That’s up to you but you have no obligations. Check out my next video, where we’ll cover cash investments.