The Balance Between Investment Performance and Risk
Translating risk tolerance and goals to an investment strategy means finding the balance between investment performance and risk. All investments are subject to some degree of investment risk and each investor has their own level of risk tolerance. This article discusses investment risk, investor risk tolerance, and how investors can manage risk to attain their investment goals.
What is Investment Risk?
Most people equate risk with losses. However, you should look at investment risk in terms of the volatility of investment returns.
The return on your investment is based on the income you receive whilst you hold the investment, and the increase or decrease in its value since you purchased it. The more volatile the return, the greater the possibility that the return to you at the time you sell your investment is not what you expected or needed it to be. In this respect, investment risk is the chance that an investment’s return may be higher or lower than expected.
The higher the expected return for an investment, the greater the potential risk (volatility) of the return will be, upwards or downwards.
Types of Investment Risk
Investment risk stems from anything that affects the value of your investments and the income you earn from those investments.
Here are 6 common types of investment risk:
Market Risk (Systematic Risk)
Market risk is the possibility of losses due to factors affecting the overall performance of the investment market. These factors can include changing interest rates and foreign exchange rates, inflation levels, political instability, changing GDP, environmental events, global pandemic such as the recent COVID-19 outbreak, etc. These factors can affect all companies in an investment market or category.
Business risk is associated with factors that affect a specific company’s profitability or sustainability, and therefore the price of its securities. These factors can include corporate decisions, changes in consumer preferences, and government rules and regulations.
Liquidity is how easy it is to buy or sell a security. Liquidity risk is the risk that you cannot sell a security at a certain price in a timely manner. This may be due to low trading volume for that security or pre-specified holding periods for some investments.
Concentration risk is the risk that arises from having too high a proportion of your investments in one security or asset class.
Horizon risk is the risk that your investment horizon (the time when you will need to sell your investments) changes because of an unexpected life event such as job loss, or illness.
Longevity risk is the risk that you will outlive your savings and/or investments.
What is Investor Risk Tolerance?
Each investor has their own level of risk tolerance. This is the personal level of risk you are willing to accept dependent on your own financial and life circumstances to achieve your financial goals.
Your risk tolerance is very much driven by your comfort with investment markets. This comfort is dependent on your investment experience, knowledge, beliefs, and personality.
What is the Difference between Investor Risk Tolerance and Risk Capacity?
Risk capacity has nothing to do with your feelings about investment risk. Risk capacity is a calculation of how much investment risk you can afford to take on, depending on your financial circumstances, investment horizon (age) and goals. It is a non-emotional determination of your ability to absorb investment losses and the time available to you to make those losses back.
How can Investors Manage Investment Risk?
Investment risk cannot be eliminated but certainly can be managed. The key to managing investment risk is understanding it. Most unsystematic risk (risks other than systematic or market risk) can be reduced by diversification, which means holding a portfolio of an efficient number of securities as well as investing in several different asset classes that optimally do not react in sync to the same market influences.
The Balance Between Investment Performance and Risk: Translating Risk Tolerance and Goals to an Investment Strategy
There is no free lunch in investing. All investments carry some degree of risk. Risk and reward are closely linked in investing. If there is a secret to investing, it is to come to grips with the risks (and the potential rewards) involved in attaining your financial goals.
If you’re a high-net-worth individual or family who is new to investing, perhaps the easiest way to manage investment risk is to work directly with a personal investment manager who can help assess your risk tolerance to effectively construct a diversified investment portfolio to your specific investment goals and risk parameters.
Since 1985, Bloom Investment Counsel, Inc. has been dedicated to providing and actively managing personalized investment portfolios for wealthy individuals, family offices, foundations, corporations, institutions, and trusts. We are a Toronto-based independent, privately-owned boutique investment management firm with over 37 years of experience managing in excess of $2.5B in assets over the years.
When you accurately assess your investment risk tolerance and invest in a portfolio that most accurately reflects your true tolerance for risk, time horizon, and personal circumstances, you are one step closer to attaining your financial goals.
Discover our personalized investment management services by visiting our website at www.bloominvestmentcounsel.com or speak directly with us by calling +1-416-861-9941 or emailing us at email@example.com
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This content is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this content should consult with his or her financial partner or advisor.