Understanding Risk

Risk means different things to different people. As we journey through life, our perception of Risk changes too.

One of the key roles of a financial adviser is to understand your attitude to Risk and develop appropriate investment strategies. In order to understand your true attitude to Risk, we really need to know you. This isn’t as simple as filling out a form and handing it in with a box ticked. There really needs to be a genuine open and honest relationship before we can get a proper barometer reading on how you respond to the challenges of Risk.  It is really very difficult to capture this information on a form.

As a client you will find we ask for this form to be updated annually. We do not want to annoy you, but we are looking for changes to your thinking or any indications that any recent market experience left you feeling different to what you expected. We have found that since 2008, some clients who were feeling very confident with Risk, now have a different view. Generally our observation is that only some clients have changed their views. We need to know about that. It is the responsibility of the client to communicate that change and make sure the adviser is aware of a change. While we meet and chat often, the Risk Profile is the official document on file to mark the change.

If you would like to request the Risk Profile questionnaire please email This email address is being protected from spambots. You need JavaScript enabled to view it. . You can email or post it back to this office for evaluation. Be aware this questionnaire is only as good as your honest and personal understanding of your reactions to past investments experiences. Please sign and date the questionnaire. This document should always be followed up with a discussion with your adviser.

When completing the questionnaire, be aware of that your current circumstances will affect responses. Be aware that your attitude to Risk will be affected by your immediate need to access survival money. So then, if you are completing this questionnaire specifically for superannuation, write “SUPERANNUATION” on the top of the form – clearly bringing to mind that you will not be able to access these funds until you are retired.
 
Your current circumstances, health, work and relationships are really very important inputs into the way you view the world and therefore Risk. We cannot over emphasise this point. If your adviser doesn’t know about it, then we can make wrong recommendations on Asset Allocation.  It really is important to have an open honest relationship about all aspects of your life with your adviser.

On a more technical level, there are many different types of Risk. You should read these and familiarise yourself with the information to give yourself more clarity.

Types of Risks

It is generally accepted that overall, growth assets will produce a higher long-term return than defensive assets. It is also accepted that growth assets generally involve more risk than defensive assets. This is known as the risk/return trade-off as illustrated in the graph below.

risk

Importantly, all investments involve a degree of risk, but the nature and extent of the risk varies. The following risks need to be considered when constructing your portfolio:

  • Investment Market Risk is the risk that all the investments in a particular market sector will be affected by an event. For example, political events and the performance of other world markets can have a significant affect on the Australian Share Market.
  • Interest Rate Risk is the risk that moving interest rates will negatively affect your investments.
  • Currency Risk is the risk that a rise or fall in exchange rates will have an adverse effect on your investments.
  • Inflation Risk is the risk that your investment portfolio does not provide a return in excess of the inflation rate to provide you with a ‘real’ return. For example, investing in cash exposes the investor to this type of risk. Although the original value of your capital is preserved, there is a risk that the buying power of your funds will be eroded by inflation over the long term if the rate of inflation is greater than the rate of interest being earned.
  • Legislative Risk is the risk that a change in government policy and legislation will adversely impact the appropriateness of the strategies adopted.
  • Liquidity Risk is the risk that you will be unable to sell or liquidate your investments in a timely manner due to exit fees imposed, limitations regarding the timing of withdrawals or a lack of buyers.

Although risk is usually associated with the probability of losing all or part of your capital, in investment terms it is the likelihood of achieving or not achieving your expected returns or goals in a given time period.  So whenever you make an investment decision it means that you are prepared to take a risk of some sort. This decision will relate to the amount of money you have to invest and your existing circumstances and your needs for the future. 

Volatility

Risk should not be confused with volatility. Volatility refers to the extent to which the value of your investments fluctuates over a period of time. For example, shares are more volatile than fixed interest and cash as share prices change daily and dividend income is generally irregular.  However, although shares are more volatile and as a consequence returns are difficult to predict over the short term, they generally provide higher returns over the long term than more defensive assets.

Diversification

As discussed, the most effective way to reduce the impact of the investment related risks and the volatility of your assets is to spread your money across different asset classes. This is commonly referred to as, “Not putting all your eggs into one basket”. Diversification enables you to achieve more stable long term returns.

Time Frame

The period of time that you maintain your investments also affects the level of risk of a chosen strategy. This is because the short-term investment returns of some asset classes, particularly shares and property, are often quite different from the level of returns that they are expected to average over the long-term. Such short-term volatility in investment returns can at times appear like a roller coaster ride. Retaining growth investments over the long term enables the volatility of returns to even out over time.

Client Login