Financially Fit & Fabulous – Wealth Builder: What is your risk appetite?

ONE of the first things your investment advisor will ask, when you meet to discuss your financial plan is, what is your risk appetite?

This question is effectively trying to assess the level of risk you are willing to take in investing. Here your advisor is seeking to determine the best approach to designing a portfolio that will balance your appetite for risk and the return you desire on your investment portfolio.

Risks on an investment offers the hope of higher returns. Riskier investments have a level of volatility that may result in potential gains or losses. There are inherent risks associated with all investments and the level of risk will vary based on the type of investment opportunities you pursue.

Risk and returns

Returns on an investment can come from periodic income (dividends) or capital gains as a result of selling the security for more than the initial price paid. It is generally true that higher returns are usually accompanied by higher risks. But, the more you venture into risky areas, the more likely it is that you could lose portions or even all the capital you are investing.  This is where diversification plays at a key role in balancing the risk return relationship.

Diversify your portfolio

Diversification is how well positioned your investment is across various asset classes example cash, income and growth. The level of risk associated with these asset classes are low, medium and high, respectively. What you don’t want is to put all your funds in investments in any one asset class if you are seeking to maximize your investment returns.

Markets operate in cycles so the performance of your investments will fluctuate or vary from time to time based on various market events; this is called market risk. Your investment advisor will give you concrete examples of the different levels of returns as well as the risks which accompany different types of investments.

When thinking of investing, people generally want to obtain high returns without thought to the risk level involved in achieving this. Investing carries with it the promise of making good gains, as well as the risk of losing your money. You will have to consider factors including inflation, volatility, interest rates, time horizon and investment allocation or mix.

How to gauge your risk appetite

Your risk appetite is what you are prepared to lose. If you are prepared to lose very little, then you will need to choose an investment type that is in the cash asset class at minimum.

If you cannot handle large fluctuations in the price of an asset, you might act on impulses. In turn, this could affect your judgement as you may encash your holdings too soon which could result in you taking minimal returns where with time, you could have earned more. 

Knowing your investor profile

In assessing your risk appetite, you should also consider your goal for the investment as well as your time horizon for investing. As you move closer to some goals, you may choose to be more conservative or take fewer risks in investing. Bear in mind also that there is a correlation between the risks associated with an investment and the time horizon which then impacts the asset classes that will comprise your investment.

Are your conservative, moderate or aggressive

There are three basic classifications for risk appetite – Conservative, Moderate and Aggressive. Generally, high-risk investors are better positioned to invest a larger percentage of their capital into growth asset class which comprise equities for example.

Stocks, also called equities, are lower risk compared to options while bonds are low risk compared to stocks and treasury bonds are lower risk compared to corporate bonds.

Stay diversified

Regardless of your risk appetite, a diversified portfolio remains the best approach to managing the risks associated with investments. Your investment advisor will help you choose the right portfolio that best suits your investment objectives. Be sure to think carefully about the level of risk you are willing to take as this plays a large role in informing your portfolio design.

Speak with an investment advisor who will direct you to the different types of investments which suit your risk appetite and also short, medium and long term goals

Latoya Virgo is a licensed investment advisor from Scotia Investments Jamaica Limited.