Risk profile and investment behaviour

There comes a point in life where we outgrow our current position in life and hope for the better. It is not a question of not being humble, but it is more of a goal to provide more for the ones dearest to us. With growth in mind, this is the time where we start to consider investments. May it be through monetary gains or growing our other resources, the prospect of investing is one that usually comes up in the conversation. To avoid chasing the rainbow, it is advisable to first make sure that we have properly put measures in place to protect what we already have before embarking on the road of adding growth to the equation.

Our financial planning topic for this week is RISK PROFILE AND INVESTMENT BEHAVIOUR. Investments can be defined as the commitment of money (or other resources) for a period of time in order to gain future profits that will reward the investor for postponing the use of their money (an opportunity cost by interest earned), for the need to earn above the rate of inflation and for the risk taken. Remember, the short-term and long-term goals on our vision board help us be mindful of the time we have set to achieve them. Breaking down our goals into smaller achievable objectives can create a solid path in the direction towards achieving our main goals. Once our goals have been identified and well-defined, financial planners make use of a risk assessment to evaluate our risk profile. This is to know which investments to consider undertaking to meet our goal objectives.

Risk Profile

Risk is usually understood as the uncertainty or insecurity that an investment will produce its expected rate of return. The consideration of risk is important when considering short-term investments (investing less than 12 months), medium-term investments (investing up to 3 years or 5 years) and long-term investments (investing beyond 10 years). Our risk profile is a combination of our risk [preference or capacity] in relation to how much we would like as a reasonable rate of return and our [tolerance] to risk with regards to how much we are willing to lose should the investment not be fruitful.

Understanding this definition of a risk profile will help you differentiate between a risk assessment done to evaluate your risk profile to choose a suitable investment product that will meet your goal objectives versus one done to define you as a threat grade to the product provider’s profitability. Be aware that not all financial advisory professionals have your best interest at heart, so do your own research to find a suitable and honest professional. Also, keep in mind that not all investment products are suitable for us and that not all investment products can meet our goal objectives. So, it is important to choose wisely.

The three common risk profile categories used are:

• Conservative investor - minimum risk exposure
• Moderate investor - medium risk exposure
• Aggressive investor - maximum risk exposure

Note that investment rates of return are estimated, meaning that these rates are NOT 100% guaranteed. Therefore, because we do not know what the future holds, we do not want to put all our eggs in one basket. A good way to balance out the investment risk throughout the time we plan to invest is by having an investment portfolio. An investment portfolio is a collection of investment assets. It can comprise of real assets which are usually tangible resources such as physical property and livestock. It can also comprise of financial assets which are usually liquid resources that can easily be converted into cash.

Financial assets can be divided into various [asset classes] such as:

• equities
• bonds
• cash
• derivatives
• and certain types of property

Each asset class is exposed to different degrees of risk such that the higher the risk exposure, the higher the rate of return on our investment. The balance of diversity among the asset classes in an investment portfolio depend on our risk profile (conservative, moderate or aggressive investor). In other words, our risk profile determines the percentages of the asset classes in our portfolio. Other than understanding the dynamics of our risk profile, it is also important to evaluate our past investment behaviour and the way we chose financial products.

Investment behaviour

People make decisions differently, and so do investors. You know yourself better than anyone. To be able to make better investment decisions in the future, take a moment to identify and recognise what influenced your financial decisions in the past.

Consider the following:

• were you quick to make conclusions based on the reliance of what seemed to be identical situations or products which you had previously experienced?
• have you made decisions based on all available information regardless of how inaccurate it was? e.g. the influence of societal views
• have you framed your decisions different from the lifetime of a particular investment?
• have you made decisions on what might have been instead of what is?
• have you made decisions based on intense fear of losing?
• have you made decisions based on the extensive grouping and evaluation of economic outcomes?
• have you made decisions based on overestimated knowledge and control ideas to achieve certainty?
• have you made decisions initially with a boundary of conditions that change with additional information to only end up back to the initial conditions?

If you answered yes to any of the above questions, your behaviour has an influence on the way you make financial decisions. Note that the way we make life decisions can vary to the way we make financial decisions. So, try switching between the mindset of making a life decision scenario and making a financial decision scenario. Do you have the same responses, or do you have different responses?

Understanding our risk profile and investment behaviour will help us protect ourselves from being taken advantage of especially in these days where scams are evolving. Let us avoid making investment decisions in a state of desperation, fear, anxiety, and other elevated emotions. When you meet some very persuasive sales personnel, know that it is okay to sleep over a possible investment decision. Do not allow yourself to feel pressured in the moment, learn to make investment decisions with a clear mind. Trust yourself and regularly track your progress on the goals you have set alongside the impact of any investment.

(This piece was first published on 3 March 2019 by The Patriot on Sunday Newspaper #RFP #CFP #WFPD2024 #FPSB #FPI #financialeducation #riskandinvestments #betteryou #wealthieryou #lightacumen)