The reality of investing is that risk is unavoidable. Ultimately, the goal of investing is to achieve the highest return at a level of risk you deem acceptable. Instead of trying to avoid risk, investors must understand the types of risks involved in various financial products and identify the level of risk they feel comfortable with.
The simplest way to identify your tolerance for risk is to reflect on how you have reacted to negative results in the past. How do you respond when the value of your property declines or when the price of your shares falls? Do you pay close attention to media headlines in times of volatility, or do you take them with a grain of salt, instead relying on your own research and analysis?
Ultimately the goal of investing is to achieve the highest return at a level of risk you deem acceptable.
These questions are a good starting point and may help reveal your risk preferences; however, a more objective method to uncover your risk tolerance is to use one of the many tools available online. Once you have established your risk profile, you can identify a portfolio structure that suits your risk appetite and investment objectives. The main difference between a low-risk and a high-risk portfolio is the ratio of growth assets to defensive assets.
A portfolio focussing on growth may include a higher proportion of shares and property; whereas a conservative portfolio may possess more cash and fixed interest assets. Cash is the most defensive asset, but the inherent risk is the capital not keeping pace with inflation, thus eroding purchasing power over time.
It is important to remember every investor is different. Age, personality, income, assets and investing experience all play a part in determining the level of risk tolerable to you. Consulting a professional adviser will help you assess your tolerance to investment risk and adjust your portfolio accordingly.
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