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The biggest driver of long term returns in an investment portfolio is the risk you are willing to take on your investment portfolio. So, what is stopping you from taking on the most risk and receiving higher long term returns?
Your Risk Profile:
Your risk tolerance is your personal ability to tolerate the volatility and price swings that your investments can have. Additionally, your tolerance will change based on what you are investing for, so not only do you need to consider what your personal tolerance is, but also how much risk you are willing to take for your objective.
Whilst you may be enticed to invest into the highest risk assets to generate high long term returns, if you cannot tolerate the significant drops in value of these assets, then you are likely to be worse off in the long run.
Everyone has heard of their relative or friend that moved to cash during the GFC or through the COVID-19 crash and never ended up investing back in the market. Instead of being invested over the long term and enjoying the benefit of those investments, they felt scared to lose any more money, or couldn’t stomach the big swings in prices. This is a great example of not having the appropriate risk tolerance to invest in the volatile assets and how this has negatively affected their long term performance. This can lead to not having enough money for their long term objectives such as retirement.
Without properly understanding what your level of risk tolerance is, you likely won’t have a portfolio that performs in line with your expectations or gives you the returns you were looking for.
How do you know what your Risk Profile is?
Determining your risk tolerance often involves a combination of objective factors, such as investment horizon, financial goals, and liquidity needs, and subjective factors like psychological comfort with market fluctuations. One way you can measure your risk tolerance is through a risk profiling assessment tool, however you need to consider if these tools will accurately profile your risk tolerance. A more comprehensive way to profile your risk tolerance is to engage a financial adviser. Financial advisers are trained to profile your risk tolerance using risk profile tools, as well as digging deeper into the psychological factors that may impact your risk tolerance, your personal situation, your experiences and the risk you need for your life goals.
As your circumstances evolve, your risk tolerance can change. Ongoing reassessment of your risk tolerance is necessary to ensure that your strategy and portfolios remain in line with your financial objectives. Ultimately, striking a balance between risk and return, while considering your risk tolerance, is a key component of successful long-term investing.
If you would like to discuss this further, or if you are not sure whether your portfolio is adequately diversified, please reach out. Our day to day work heavily involves ensuring our client’s portfolios are suited to their risk profile and objectives, as well as being adequately diversified.
Author: Harrison Trippett
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