Attitude to risk

SmileY_4

Afternoon

I was just wandering what everyones attitude to risk is and whether you opt for income or growth profiles???

i started out with my S&S isa in 2002 with a low-medium risk.

everytime i see charts the more riskier always gets higher returns in a longer term (5+ years).

so when confronted by a FA asking me my attutide to risk what should I say ... im not clueless but im not exactly knowledgable either!!

Any opinions or help much appreciated.

SmileY

jon3001

SmileY wrote: »

everytime i see charts the more riskier always gets higher returns in a longer term (5+ years).

so when confronted by a FA asking me my attutide to risk what should I say ... im not clueless but im not exactly knowledgable either!!

The price of the increased return is usually increased volatility and probability of making a loss (risk). If your portfolio was down 10% on the month would that bother you? How about if it ended the year over 30% down? Do you then panic and sell out at a loss? Or do you ignore these short term capital fluctuations and rely on the potential for higher returns over the longer term?

Note: attitude to risk isn't the same as capacity for risk. If this is money you need sooner rather than later you need to go for a less risky portfolio.

meester

This is correct.

The risk premium reflects the fact that you will be rewarded for taking on more risk. The higher the risk the higher the likely return in general.

This is true in life as well. I tripled my income inside a year by taking risks with my career. I could afford to this because I had acquired a fair bit of money, which made me comfortable to take the risk. Had I taken the risk sooner, I would be slightly better off now than I am. Same applies with property investments, etc., as well, if you don't take the risk (and by its nature, a risk can go completely wrong), you will never acquire any wealth.

The problem is that there are times you will lose badly. Can you afford the downside, mentally, and in terms of having cash to support yourself and rebuild? I accumulate more savings in a year than I currently have invested in volatine investments, so if my risky investments fall by 80%, it won't affect me in the slightest, although it would still annoy me a great deal, and perhaps make me act irrationally. There are then two aspects to risk tolerance - the extent to which you can afford to lose the money, and the extent to which you are comfortable with losing it.

If you are 55, unemployed with no job prospects, and £100k in savings, then a 20% fall in the value of your savings would cause mental anguish, but also hardship as well.

For many people, their volatile investments may not represent any particular need fulfilment, and hence they satisfy the fact that they can afford to lose the money, but it is very difficult to mentally get accustomed to losing money, especially when there is always always fear that things will not get better, because markets are not as mathematically predictable even as a roulette wheel, where you can say you will win 1 in every 37 times, with the market, you can never know.

Even if your investment money does not serve any immediate needs, if you take risks with say £500k, built up over 20 years of investing, and lose half of it due to excess risk taking, even though you might have a good job and not suffer in your lifestyle, you will not get back to that £500k point for a very long time.

This is why people should not in general risk significant parts of their wealth in volatile investments, because they can get wiped out, and it is game over.

These bets are essentially dice weighted in your favour - if you keep betting all of your wealth that the dice will not come up on a six, you can win year-after-year, but eventually it is 100% certain that you will lose all. People argue that taking excessive risk is worthwhile, because it has worked for them so far, but few people that do this, simply because they are risk-takers by nature, will stop before it goes horribly wrong.

Debt_Free_Chick

Risk of what, though?

surely there are a number of different types of risk. Volatility is only one of them ....

meester

and just btw, even though higher risk is generally higher return, the expected return of multiple different high-return investments is not lower than the expected return of just one. What it does do is reduce volatility. Some people are insane risk takers, and will bet 100% of their wealth on the Indonesian stock market hoping for it to double in a year, because they CRAVE variance, but their AVERAGE return is not higher than someone who spread 25% each around say Indonesia, Peru, Africa, and India.

It's all very well to say 'investment x doubled last year', and it's possible it will do it again, but for nearly everybody, investing in three different investments that all have the potential to do this, but are not totally correlated with each other is better, because although your total investment is very unlikely to double, your average return is not reduced, and you will not be left in the 'rebuild from scratch' scenario.

meester

Debt_Free_Chick wrote: »

Risk of what, though?

surely there are a number of different types of risk. Volatility is only one of them ....

Risk of losing money of course.

That is what people need to worry about, however it might manifest itself.

jon3001

meester wrote: »

and just btw, even though higher risk is generally higher return, the expected return of multiple different high-return investments is not lower than the expected return of just one. What it does do is reduce volatility.

Indeed, providing the investments are sufficiently uncorrelated, it's actually possible for an annually rebalanced portfolio to generate higher returns than its best performing component. And with lower volatility.

SmileY_4

Debt_Free_Chick wrote: »

Risk of what, though?

surely there are a number of different types of risk. Volatility is only one of them ....

well what is risk in a brochure???

ive always understood it to be how "secure" do you want the investments.

The low risk investments are those that you are less likely to make a loss but the gains will be small.

Higher risk, as mentioned above, can be very volatile but are more likely (in some cases) to make a higher gain.

[qoute=jon3001;9707155]
The price of the increased return is usually increased volatility and probability of making a loss (risk). If your portfolio was down 10% on the month would that bother you? How about if it ended the year over 30% down? Do you then panic and sell out at a loss? Or do you ignore these short term capital fluctuations and rely on the potential for higher returns over the longer term?

Note: attitude to risk isn't the same as capacity for risk. If this is money you need sooner rather than later you need to go for a less risky portfolio.
[/qoute]

It would probably be a medium term (3-5 years).
Would I be annoyed at losing 10/30% -- who wouldnt be ... but as long as after this period I had made some gains. Im just trying to sort this out in my head thats all.

I had an independent FA with me in 2002 and he asked me attitude to risk. As an 18 year old petrified of giving my money away let alone losing it lol. But now im 23 I can afford to understand risk and take it. I will have ISAs as my low risk but I would certainly like some medium-higher ... but how do you find your investments???

bank fa, independent fa, friend, yourself???

im likely to get a lot of things thrown at me by the bank fa tomorrow. the independent fa gave me a s&s isa with fidelity which even though was low risk has made some nice returns ... although recent events wiped out some of that profit.

any ideas welcomed

jon3001

SmileY wrote: »

It would probably be a medium term (3-5 years).

That's definitely on the short side for investing. Shorter time horizons increase the probability of a loss since the portfolio has less time to recover from adverse market swings.

SmileY wrote: »

Would I be annoyed at losing 10/30% -- who wouldnt be ... but as long as after this period I had made some gains.

Who wouldn't be? People with long investment horizons that accept these fluctuations as a natural part of investing.

What it you hadn't made any gains? Would -30% be merely annoying or a problem? Is there a maximum downside that you can tolerate?

dunstonh

When you invest, you know there will be sustained periods that you will see a negative return. Just ask anyone that invested in the last 18 months.

The problem is you dont know what order it will come in. Will you see a 30% gain before the loss or will you see the loss before the gain?

im likely to get a lot of things thrown at me by the bank fa tomorrow.

A bank tied insurance salesman cannot touch an IFA for availability of investments and charges.

It would probably be a medium term (3-5 years).

Thats not medium term. Thats very short term and not enough to be investing. Medium term is around the 7-10 year mark

baby_boomer

dunstonh wrote: »

Medium term is around the 7-10 year mark

The concept of "medium term" has undergone a revision upwards in IFA Speak over the last decade . It used to be 5-7 years before stock markets lost their post WW2 shine.