subject: Investment Risk - What's Your Risk Tolerance? [print this page] As you'll know, the main global stock markets have been VERY volatile over the last 12 months or so.
And it's likely that you have money invested in one or more of several investment vehicles:
ISAs
Personal Pensions
Self Invested Personal Pensions
Life company funds
Unit Trusts
Open Ended Investment Companies
Investment Trusts
For example, if you have capital invested in ISAs and personal pensions, you may well have your money invested in up to 20 separate investment funds.
Knowing how much risk your overall portfolio (not just the individual funds) is subject to is a crucial part of investing.
It's not good enough just to know how the funds may have performed in the past - this just tells you part of the story.
What you need to know is:
what is the volatility of the overall portfolio?
does this suit the amount of risk you're comfortable with?
and, does it suit the amount of risk you NEED to take?
So, the first step is to find out how much of your capital you would be prepared to see fall in value before you took any action, positive or negative.
This is your risk tolerance.
For example, if you have 100,000 invested and you don't need access to the money for 20 years, you may well be prepared to see a fluctuation of up to 25% in any given year.
Next, you need to know what the volatility of each fund is. This may also be referred to as 'standard deviation'. This one factor will indicate how risky the fund is.
As an example, if a fund has achieved an average annual growth figure of 11%, you may well want a piece of the action. However, if the volatility factor is 22, then the fund's range of performance in any given year is:
33% (11+22)
minus 11%
This may well be too much risk to bear.
Once you know the volatility, you need to link it back to the impact that the loss of capital would have on your short, medium and long term financial plan. You may find that even if you lost 50% of your capital, you would still achieve your income goals in retirement and any other goals.
By knowing this one factor alone, you may well end up making a different decision than you would have done (with your invested capital).
I know we've looked at the negative here - the reverse may also happen and the higher volatility could mean that you end up with a higher amount of money than you would have done.
The Financial Tips Bottom Line
I hope you've grasped the point - there's SO much more to investing your money than by simply picking a few investment funds based on their past performance.
Find out how much risk you are REALLY taking with your invested capital. It's a logical thing to do as you had to earn the money in the first place, so surely it deserves to work as hard and efficiently for you as possible?
by: Ray Prince
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