Some of us scale mountains or dive out of planes in our spare time. Some of us prefer chess or curling up with a good book. How we spend our spare time says a lot about our risk tolerance and the same applies when it comes to our investment choices. Adrian Starr, Director and Wealth Manager at Peregrine Wealth, analyses how your personal appetite for risk can be transferred into your wealth choices.
Over the course of 2020 many investors came face to face with their investment fears, causing them to realise that their investment risk tolerance was more conservative than they thought. Understanding your risk preferences may therefore require the setting of new targets and goals to protect against similar events in the future.
In determining your risk preference, we will start by carefully considering factors such as investment time horizon, type of investment vehicle, required market participation and future cash-flow requirements. The goal or target set by the investor also plays a crucial role – this can be set as wealth preservation (matching or beating inflation), capital preservation (avoiding any loss in the nominal value of the capital) or an absolute/relative value.
It is also important to consider the following criteria in determining your target and goals:
- Liquidity: the ease with which assets can be converted to cash when funds are required to cover expenditure over a short period of time.
- Income: the cash-flow anticipated to maintain your lifestyle.
- Capital preservation: needing to avoid a significant decline in the value of your capital.
- Growth: the desire to see capital appreciate over time.
Finally, your risk preference will be influenced by the type of investor you are. Broadly speaking, investors can be divided into those seeking to accumulate wealth (mostly pre-retirement individuals) and those seeking to preserve wealth (mostly retired).
A BLUEPRINT DESIGNED JUST FOR YOU
All these goals and preferences are then merged together to create a unique financial plan and wealth preservation strategy. The profound economic impact of the Covid-19 pandemic on markets and economies has highlighted the need for having a robust financial plan which caters to your particular risk tolerance level. For those of us in the wealth management business, this underlines the importance of an appropriate and disciplined investment strategy – one that is capable of seeing you through the boom times, as well as tumultuous periods such as those experienced during the COVID lockdowns.
A well-crafted and long-term financial plan – which incorporates a clear understanding of your personal risk appetite – is a guiding light during times of market upheaval and global financial challenges, when keeping emotions in check is so critical for any investor. Coupling this with the right risk fit helps to ensure your discipline and commitment to the plan, even when times are challenging and the behaviour of markets is perplexing.
GETTING TO GRIPS WITH RISK
If we all had perfect foresight, there would be no risk. But we don’t, which means we have to deal with the impact of risk in our investment strategy.
For most of us risk means the possibility of losing something. It is associated with a state of doubt, the potential for future harm or even loss. It talks of potentially deviating from the expected and poses the threat of not achieving a cherished goal.
In the West it is commonly believed that the Chinese written character for risk is a combination of the character for ‘danger’ and the character for ‘opportunity’. This is not strictly true but the misperception speaks to a broader truth – any activity that has an inherent danger tends to have associated rewards to compensate. For example, the risk of bungee jumping off a bridge is rewarded with the huge endorphin rush experienced by the jumper. Therefore, we would expect there to be a positive relationship between risk and reward.
In other words, the absence of risk equates to the absence of return and, by extension, we cannot obtain returns without taking on some level of risk.
WHAT ARE YOUR RETURN EXPECTATIONS?
Every investor seeking return – whether for retirement, further studies, preservation of capital or income generation – should really take the time to get to know and understand their risk preference before they invest. Once you fully understand how you view risk, you will know where and how much to invest and what return to expect. It will also enable you to manage your future expectations and expenditure.
Some investors are concerned about relative risk (underperforming a benchmark or target) and others might be concerned about absolute risk (losing money). Therefore, some investors might be worried about their real drawdown (maximum loss below inflation), others might want to minimise their portfolio’s shortfall to a benchmark and still others might want to reduce their value at risk. Clearly, the definition of risk is extremely important, and each and every investor should be comfortable with their risk preference.
At Peregrine Wealth we pride ourselves on having a team of experts that includes highly qualified and experienced advisors. These individuals bring all their know-how to the table to help design your ideal financial roadmap, which takes into account your risk preferences. Most importantly, you can draw on the input of these experts to construct a bespoke investment portfolio that is actively managed and fully in line with your specific objectives and risk appetite.
You can contact Adrian to discuss your risk and reward preferences here.