“The return of my money is more important than the return on my money” Mark Twain.
That’s an interesting sentiment.
When asked what your attitude to risk is, how many of you consider you are simply ‘medium risk’ or ‘three out of five’.
“Risk comes from not knowing what you’re doing” (Warren Buffet), or alternatively from appointing someone as your expert who doesn’t know what they are doing!
Many investors agree their risk levels with an adviser, without really understanding what the parameters are and subsequently the decisions they make are of similar quality. The process of discussing your investment risk should take about an hour to two hours.
What does risk mean? To some, it’s how much money you can lose, to others, it’s the potential for fluctuation.
Risk can be a very personal matter.
It’s natural that we are ‘high risk takers’ when the market is rising (we know we can’t lose), and ‘low risk takers’ when the market falls (we don’t like losing).
Unfortunately markets don’t work that way. You are one or the other.
To decide your risk you can follow the ‘painting by numbers’ approach used by some which involves drawing a pyramid and asking you which you would prefer to go for. Most people will go for a number 3 out of 5, or the middle section of a pyramid. Both of these examples are to bad decisions what the word ‘boring’ and politics are to each other.
To decide what your attitude to risk is, you must first decide what you want from your money. Understand your potential need and everything else will follow. Once you have decided that need, an investment adviser can tell you what potential fluctuation you might expect. If you are unhappy with that potential fluctuation you would simply have to reduce your potential for gain. There is no magical solution here and each are in line with each other.
The general need for risk comes from the requirement to beat inflation. Inflation erodes the value of your capital in real terms. Consider that from 1985 to 2004 your capital would have needed to have grown by 98% to stay at the same value as inflation had eroded that.(1) A building society would have returned 168%, or a real return of 3.68% per year. Hence most investors realise the need to invest to achieve the best real returns. Property, corporate bonds, equities and Gilts are just some of the investments chosen by investors. Each can fluctuate at different levels. A fluctuation upwards is called a gain and downwards is a loss.
The key when investing is to minimise the losses and maximise the gains and that can be achieved not only by understanding correctly what you are investing into, but also managing your investments on an ongoing basis.
For example, in 2006 was it a good idea to say that property was a good idea to invest into because it had gone up so much? Hardly; it’s a cyclical asset that performs well at certain times and you don’t want to hold it when it isn’t performing – the downturn can be for a very long period.
It is essential to review your attitude to risk on an ongoing basis. For example, if you had been high risk and then had performed well, you might consider you are now a higher risk where actually it may be better to take a lower risk. A diversified investment portfolio is essential, as each of the aforementioned investment assets behave differently at varying points in the economy.
Finally if I could give one tip it’s that you take gains on your investments rather than believing they will continue to go up. This is the most ill-used investment discipline. Understanding it is knowing that no investment is good or bad, it’s just your thinking that does that.
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The value of shares and investments can go down as well as up