All investment carries risk – or to use a less intimidating word, uncertainty.
Uncertainty is something you probably don’t want in your financial planning, but the truth is some risk is essential to maximise your returns, because safe investments are rarely produce the highest returns.
Savings, which stay as cash can offer predictable returns. Investments are different, because with an investment, you can’t be certain what you’ll get back when you finally cash it in.
So how do you manage risk?
Different assets offer different levels of risk so by carefully assessing the risk inherent in different types of assets, you can create a balanced portfolio, with a level of risk you feel comfortable with.
This is known as asset allocation. It’s the basis of sound investment strategies.
The major asset categories
Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you’ll reduce the risk that you’ll lose money overall.
Stocks – Stocks have the greatest risk and highest returns among the major asset categories. As an asset category, stocks offer the greatest potential for growth. As we all know, a stock can go up fast – and fall just as dramatically. The volatility of stocks makes them a very risky investment in the short term, but investors that have been willing to ride out the volatile returns of stocks over long periods of time generally have been rewarded with strong positive returns.
Bonds – Bonds are less volatile than stocks but offer more modest returns. They tend to be considered as safe. An investor approaching a financial goal might increase his or her bond holdings relative to his or her stock holdings. However, certain categories of bonds offer high returns similar to stocks. But these bonds, known as high-yield or junk bonds, also carry higher risk.
Cash – Cash and cash equivalents – such as savings deposits, certificates of deposit, treasury bills, money market deposit accounts, and money market funds – are the safest investments, but offer the lowest return of the three major asset categories. The chances of losing money on an investment in this asset category are generally extremely low.
Property – property investment is generally low risk, with predictable returns. It is traditionally regarded as an investment for incomes, although it can often now demonstrate attractive capital growth.
Commodities – Using commodities as an investment usually means buying funds that hold the underlying commodity, so you participate in the change in value on the world markets. The risk is moderate, and returns should be predictable – but surprises do happen. Anybody who had invested in oil in recent years would have been in for a nasty shock.
What’s the right asset allocation for you?
The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk.
If you’re a younger investor you may want to invest in assets with a higher potential for growth but greater risk, because you have time to benefit from their long term growth, and you’ll have time to invest again if things don’t work out. If you’re nearing retirement you may want to choose more conservative investments that are steadier in both risk and return.
Determining the appropriate asset allocation model for you is a complicated task.
Basically, you’re trying to pick a mix of assets that has the highest probability of meeting your goal at a level of risk you can live with. Many financial experts believe that your asset allocation is the most important decision that you’ll make with respect to your investments – that it’s even more important than the individual investments you buy.
But you need to stay in control.
As different asset classes perform differently in different circumstances you’ll need to keep a watchful eye over your investments to take advantage of ever changing market conditions. That’s why it makes sense to get professional to help you determine your initial asset allocation and suggest adjustments for the future.
You’ll be able to discuss your attitude to risk and your market timing, and use it to shape your asset allocation.
Call our investment professional to discuss how they can deliver the help you need.
The value of investments can go down as well as up and you may not get back the amount invested. Past performance isn’t an indicator of future performance.