What is your defined investment objective? Is it like, “I want to grow £150,000 into £300,000 plus inflation over the next 10 years”, or are you happy with “I want a good return”? Realistically, you are unlikely to achieve the first unless you accept investment risk that says, in effect, “Go for Growth” with a broad asset allocation that is at least 75% Growth assets (equities from across the world).
Risk profiling aims to ensure recommendations are suitable for each investor. However, an investment objective that requires a return averaging 10% a year is unlikely to be achieved with a ‘risk averse’ profile. Generally, the greater the risk, the higher the return (reward) and it is unlikely, for example, that a low risk security will give a high return.
In defining a risk profile, a description, such as ‘risk averse’ or a number, such as 7 out of 10, tells us very little about the investor’s perception of risk. In a post in May 2016, “Risk, how do you define it?”, I sought to define risk with more specific descriptions.
Risk, what is it?
‘Risk’ is uncertainty. When you select an investment, it is unlikely to give exactly the result you expected. Most people see risk as something that leads to a loss of capital or a loss of income. They accept that volatility is not risk although it is often upsetting. The failure to achieve a desired result is clearly an investment risk, which will happen from time to time.
Spreading the Risk
More important than the selection of individual securities is the management of a portfolio to maintain a good spread of investment (jargon – diversification) whether the broad asset allocation is 100% Growth or 100% Defensive or somewhere between those extremes. The three mainstream asset classes of Fixed Income, Commercial Property and Equities, should be included in all but the most extreme aggressive or risk averse portfolios.
Sovereign (government) bonds issued by the developed economies (UK and USA attract most attention) are regarded as safe havens but in recent years prices have been bid far beyond par and are now falling back. This is a secular change and may last for several years so that those who are holding the bonds today are likely to suffer considerable losses.
Mr Trump’s election as the next president of the USA is likely to boost the value of the dollar. Developing economies may suffer because dollar loans will cost more to repay.
Risk is forever with us even for the most cautious. Cash, for example, is trashed by inflation and equities can soar or die. But, no risk probably means no return. What do you want?