For an investor, understanding your appetite for risk and how to manage risk is vital. Here we look at three interconnected aspects of risk which need to be analysed to determine your specific risk profile. Investment solutions are then designed to correspond with your risk rating.
Risk tolerance is a subjective concept relating to the emotional or psychological aspect of risk and the extent to which a person is ‘willing’ to accept risk and the possibility of suffering financial loss for a possible higher investment gain. It also relates to resilience and the patience needed to be able to withstand investor uncertainty and volatile financial market conditions. Those with a lower tolerance for uncertainty tend to panic and may resort to selling at the wrong time and jeopardising the potential of the long-term investment strategy.
In the same way that risk tolerance differs from person to person, it may also vary during the lifetime of an individual depending on age, family scenario, income and financial goals.
It is the skill of the expert financial planner to blend these three elements of risk to customise investment strategies to suit each individual investor
Risk capacity looks at the extent to which an investor’s financial plan is strong enough to withstand certain negative events without entirely derailing their important investment goals. Investors with larger portfolios are more likely to have the capacity to take on greater investment risk and volatility.
Risk required refers to the level of risk that needs to be applied in the selection of the financial products that are chosen to meet the client’s financial goals.
It is the skill of the expert financial planner to blend these three elements of risk; risk tolerance (the human emotional element), risk capacity (total available financial resources) and risk required (financial goal aspect) to customise investment strategies to suit each individual investor with a view to achieving their investment goals.
Left alone, investors can become fearful in the face of short-term losses and sell when an advisor should coach them to hold their investment for the long run. Similarly, boosted by the confidence a star performing investment inspires, inexperienced investors often buy ‘yesterday’s winners’ at the top of the market. The result of unmanaged risk can have a disastrous effect on finances.
‘Following the herd’ is probably not in the best interests of financial survival
Most of us can recognise the pattern and can remember examples: the euphoria as everyone clambered to buy dot-com shares as the market peaked only to watch them fall like a lead balloon. We can’t blame ourselves. The ‘follow the herd’ mentality is hard wired into our psyche and ensured the survival of the species over millennia. But that is precisely why a partnership with a professional independent advisor is so valuable to successful long-term investing.
Submitted March 14, 2017 at 08:27AM by Rutherford_Capital http://ift.tt/2mnm7jW
