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Investing involves risk.  Each of us is unique, and understanding how much risk you can tolerate is fundamental to shaping your own investment strategy.  During the Global Financial Crisis, so many people forgot about or did not understand their own unique risk tolerance to their peril.  This is how we ended up with the travesty of Storm Financial convincing retirees, with no income, to borrow against their homes and invest into high risk investments on the stock market.  Different investments have different risk characteristics.  Understanding your risk tolerance, will help to decide which investments have the right fit for you.

So what is risk?  I define risk, in the investment sense, as the likelihood of losing money.  Be warned, strangely enough, many in my industry do not see it that way.  Fund Managers, people who invest your money in a range of investments on your behalf, often see risk as the risk of underperforming the market.  This means if they lose you 10% of your money but the market loses 20% they think that they have done a good job! Oh, thank you so much Mr Fund Manager for losing my money so well and charging me fees for it too! (I will write more on how they get away with this later).  In my opinion, losing money is losing money, doing it better than anyone else is not the aim of investing.

So how do you figure out your risk tolerance? Given your ability to handle risk is entirely unique to you, there are a range of factors you should think about in deciding how much risk you can handle including:

  1. Your Age – generally speaking the younger you are the more risk you can afford to take as you have more time to ride out any fluctuations in markets and make up for any mistakes.
  2. Your Goals – what are you investing for?  If you are investing for your retirement, depending on your age, the long term nature of the goal means that you could afford to take more risk than if you were planning for a holiday in a year’s time (short term goal).  When my husband and I were saving for our house we were invested in markets for the first few years but then as we started to get serious about purchasing we put the majority of our deposit into cash.  Yes, we missed out on some returns (we brought our house pre GFC), but for us given that we thought a purchase was imminent, it became more about preserving our deposit than making extra money.
  3. Your Circumstances – this includes things like are you thinking of having a baby?  How stable is your job?  How good is your health? How secure are your current financial circumstances?
  4. Your Personality – how risk averse are you in your daily life?

Another clue to your risk tolerance is to think about how you would feel if the value of an investment dropped by 20% overnight.  As all parents know, you should avoid losing sleep at all costs!  If such a scenario would cause you to lose sleep then it is likely that high risk investments are not for you.

Like everything risk tolerance is a spectrum and it is crucial to remember that your risk profile changes over time.  The risks I could take in my twenties when I was single, are different to what I can take now that I am married with a child and this will be different again as I approach retirement, which thankfully is still a fair distance away!

Understanding your own risk tolerance is key to making sure each investment you make is right for you.

Next on our investing journey we are going to look at the fundamental relationship between risk and return.  Many investors get scammed as they fail to understand this essential rule of investing, then we will look at the risk characteristics of broad investment groups so you can see how they relate to your risk tolerance.

If you liked this post check out the rest of the series by clicking on the links below:

Investing: How Do I Get Started?

Risk and Return

What Are My Investment Choices?

Fixed Interest Investments

Property Investments

24/04/2013 2 comments
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On June 18th last year it was my birthday, a day like pretty much any other.  My husband and I dropped our beloved daughter, Miss Money at childcare and I went off to work.  About mid-morning, I passed a team mate in the photo copy room and we had a quick chat when he confided in me that he was scared that he was going to be made redundant.  I told him that if anyone in the group was going to be made redundant it was going to be me.  I returned to my desk to finish my research report and not more than half an hour later it happened to me!  My boss pulled me into a room and that was it.  I was told it wasn’t anything to do with my performance, it was cost cutting and there would be several of us who would be going.

For me it wasn’t completely unexpected, things had been tough since my return from maternity leave 11 months prior and let’s face it I am not the first mother to return from maternity leave only to be made redundant.  In our case, Miss Money had been sick a lot.  When I say a lot I mean at least every second week and to the point where I remember sitting in the doctor’s office on my third visit for the week saying “I am not the Munchausen lady, I promise” (Munchausen by proxy syndrome is form of child abuse that involves the overstatement or fabrication of illnesses or symptoms by a key caretaker.)  On the journey we found out she had an egg allergy, asthma and an intolerance to wheat all of which were not helping but we found juggling everything with a sick child very difficult.

 For me I saw my redundancy as one big birthday present – a great opportunity.  It was my chance to get off the merry go round for a minute or two, catch my breath and not only enjoy more time with Miss Money but assess what I wanted to do next.  They say you have several careers during your working life and I am just starting to embark on a new one.  From stock market analyst to mummy blogger with a passion for helping parents get the most from their money.  I have always wanted to run my own business so I am standing on the edge and have decided to jump, I might fall, I might fly but I am certainly not going to waste the opportunity my birthday present has given me.

05/03/2013 0 comment
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