Many of you may be currently sitting on losses within your investments and pensions. As it happens, at the time of writing, stock markets have rebounded significantly but the sharp decline earlier this year probably tested your resolve. The key to being able to sit tight and stick with your investments is to make sure that you’re taking the right amount of risk for your emotional tolerance and personal circumstances. Risk and return are related to each other. On a long-term basis, risk should be seen as opportunity, not danger. If we leave all of our money in the bank, we won’t beat inflation and will suffer a reduction in purchasing power. This is really damaging over long periods.
There are three elements to deciding how much risk to take within an investment portfolio. Firstly, consider your emotional tolerance to risk. We ask clients to complete a psychometric questionnaire after which we chat through long-term data showing the best and worst returns for varying levels of risk over different timescales. Our mantra is that all downturns will be temporary. They always have been and probably always will. There’s very little point in assuming anything else. We’ll help you decide how much of a temporary downturn you could emotionally handle. Then consider your financial capacity to take risk. We produce a lifetime cash flow forecast for all clients, estimating income versus expenditure way into the future. We allocate any money required in the early years of your financial plan to cash or high quality bonds, rather than the stock market.
When we measure your financial capacity to take risk we are calculating how much risk you could take without having to materially alter your plans in the event of a major stock market downturn. This is a mathematical calculation rather than an emotional decision. Finally, consider your need to take risk. We look at the long-term rate of return that is required from your investments to give you a viable financial plan. The higher the level of risk, the higher the long-term rate of investment growth that we can assume. Making a decision. Each of the three elements of risk need to be taken into account and there will be inevitable trade-offs to discuss. This isn’t a simple exercise, but the role of the financial planner is to explain everything clearly and guide you through. It won’t surprise you to learn that we can help with this! Please do get in touch if you’d like to have a chat.