Sunday, May 21, 2006
Your investment profile
Before we discuss some of the strategies to mitigate investment risks...it's also very important, prior to making any investments, to determine one's investment profile which relates to risk tolerance, resources, time horizon and goals.
Risk tolerance
It's a measure of your comfort level with regards to the ups and downs a particular investment. Sometimes, in determining risk tolerance, the amount of risk one's financial condition will allow one to take, and how much risk one is willing to take might differ. Ask yourself, how would you react if you were to lose 1-15%, 15-30%, 30-45% or even >45% of your investment portfolio, even if you knew it would probably grow back in the long run? Often, investors are not fully aware of their risk tolerance until an actual market event takes place to 'test' their investment resolve...which sometimes can be too devastating for some investors. It's very important that you know where you stand before any investment loss occurs.
I'd also like to highlight that risks and gains are directly correlated - as you must have heard this umpteen times 'high risks, high returns..low risks, low returns'. Those investors who aren't willing to take risks will have to make do with lower returns.
Resources
Draw up a personal financial inventory and budget listing all your assets, liabilities, income and expenses. Do you have a large excess each month after deducting all of your expenses from your income? Do you have an emergency fund (at least enough money to cover 6-mths of expenses) to provide for some liquidity in times of unforeseen circumstances? Do you have a large amount of savings (in excess of emergency fund) in the bank which is yielding very low returns? Do you have large amount of funds in CPF (which you do not need for housing/education in the near future) that are left idling in the CPF-OA/SA?
If you've already set up an emergency fund and still have a lot of money left over from your monthly income (less expenses), personal savings as well as funds in your CPF that you don't see yourself needing in the mid-long term...you can then invest the money and perhaps take on a bit more risk as your financial condition allows for it.
Time horizon
Your investment time horizon is a measure of how much time you have until you will need the money. Generally, the longer the investment time horizon, the more risk one can afford to take, since over time, high short-term volatility tends to lead to strong long-term gains.
Sometimes, some of my clients can get quite anxious about short term volatility even though their investment horizon might be 20-30years! Volatility is nothing but a detail (or 'noise')...short term volatility does not matter if your financial objective is for the long term. Even if your portfolio were to drop 30 per cent today, you are fine as long as you do not sell when prices are low.
Goals
Your investment profile is shaped by your goals. Are they long-term or short-term? Are they 'needs' or 'wants'? Do the goals affect only you or do they impact others (i.e. children, family) as well?
Based on your goals, you can then determine the amount of risk you have/are willing to take as well as the amount of resources that you'll have to commit (& forgo other needs/wants) to increase the probability of realising your goals.
In conclusion, your investment profile is determined by a kaleidoscope of factors such as your tolerance for volatility, attitude towards investing, resources, time horizon and goals. Once you have identified where you stand based on the numerous attributes, you will then have a clearer picture of your investment profile - which will dictate how you'd go about setting up a personal investment portfolio subsequently.
Risk tolerance
It's a measure of your comfort level with regards to the ups and downs a particular investment. Sometimes, in determining risk tolerance, the amount of risk one's financial condition will allow one to take, and how much risk one is willing to take might differ. Ask yourself, how would you react if you were to lose 1-15%, 15-30%, 30-45% or even >45% of your investment portfolio, even if you knew it would probably grow back in the long run? Often, investors are not fully aware of their risk tolerance until an actual market event takes place to 'test' their investment resolve...which sometimes can be too devastating for some investors. It's very important that you know where you stand before any investment loss occurs.
I'd also like to highlight that risks and gains are directly correlated - as you must have heard this umpteen times 'high risks, high returns..low risks, low returns'. Those investors who aren't willing to take risks will have to make do with lower returns.
Resources
Draw up a personal financial inventory and budget listing all your assets, liabilities, income and expenses. Do you have a large excess each month after deducting all of your expenses from your income? Do you have an emergency fund (at least enough money to cover 6-mths of expenses) to provide for some liquidity in times of unforeseen circumstances? Do you have a large amount of savings (in excess of emergency fund) in the bank which is yielding very low returns? Do you have large amount of funds in CPF (which you do not need for housing/education in the near future) that are left idling in the CPF-OA/SA?
If you've already set up an emergency fund and still have a lot of money left over from your monthly income (less expenses), personal savings as well as funds in your CPF that you don't see yourself needing in the mid-long term...you can then invest the money and perhaps take on a bit more risk as your financial condition allows for it.
Time horizon
Your investment time horizon is a measure of how much time you have until you will need the money. Generally, the longer the investment time horizon, the more risk one can afford to take, since over time, high short-term volatility tends to lead to strong long-term gains.
Sometimes, some of my clients can get quite anxious about short term volatility even though their investment horizon might be 20-30years! Volatility is nothing but a detail (or 'noise')...short term volatility does not matter if your financial objective is for the long term. Even if your portfolio were to drop 30 per cent today, you are fine as long as you do not sell when prices are low.
Goals
Your investment profile is shaped by your goals. Are they long-term or short-term? Are they 'needs' or 'wants'? Do the goals affect only you or do they impact others (i.e. children, family) as well?
Based on your goals, you can then determine the amount of risk you have/are willing to take as well as the amount of resources that you'll have to commit (& forgo other needs/wants) to increase the probability of realising your goals.
In conclusion, your investment profile is determined by a kaleidoscope of factors such as your tolerance for volatility, attitude towards investing, resources, time horizon and goals. Once you have identified where you stand based on the numerous attributes, you will then have a clearer picture of your investment profile - which will dictate how you'd go about setting up a personal investment portfolio subsequently.
