Monday, February 24, 2020

Matching your portfolio to your risk aversion: A guide

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Matching your portfolio to your risk aversion: A guideThe basic problem of investing is matching your portfolio to your attitude to risk.

Of course, “no risk” investments are nearly impossible, but depending on your investment outlook there are ways to mitigate your vulnerability.

This requires you to look inward – and ask yourself where you stand on the risk spectrum.

For example, if you think back to 2008, do you feel panic at the dot com crash? Or calm? Or perhaps something in-between?

The simple fact is all markets recover – and if you were aware of this at the time you may have found solace in the silver lining of the situation – cheaper options to diversify your portfolio.

And that is the key. Creating a rational, risk-adjusted portfolio requires a mix of bonds, commodities foreign equities, stocks, and real estate – all suited to your own aptitude for risk.

Your investor type

If you are a ‘Type A’ investor – either older and more risk averse or simply more affected when markets move, maintain investments in the slower-moving and therefore less volatile options.

If you are fearless, young, or have the surplus capital to take larger risks, you are the other type of investor – for the purposes of this article a ‘Type B’ investor.

Type Bs can afford to purchase the more unpredictable, stock-heavy positions. This should ensure you experience superior results in the long term – particularly true if you are not susceptible to flee an investment at signs of trouble.

The questions to ask yourself

For either type of investor, there is risk.

However by increasing your awareness and understanding of certain key pointers, you can – if not completely erase the risk – diversify your portfolio sufficiently to remain afloat even in tough times.

  1. Overlap. Overlap creates risk by lessening the diversification of your portfolio. The problem is that it is only with time and effort spent investigating your options that will reveal any overlap. Even if you invest in a multitude of different mutual funds, with different investment objectives, you might find you are repeatedly investing in the same companies.
  2. Following on from this, remember subjectivity is the enemy of your portfolio. Fund managers will naturally have biases. If they prefer value investing, or small cap stocks, bias in your portfolio will follow. To counter this, ensure you’re asking the right questions, and pointing out any concerns within your portfolio.
  3. Hidden costs can undermine your portfolio if you aren’t ready for them. Whilst your broker is required to supply you with a prospectus detailing costs and returns, unless you complete the necessary due diligence, you may not understand how much your investments are going to cost. Generally speaking, the further you go from well-known investments, such as the S&P 500 Index, the larger the operational costs.
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