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INVESTING IN TIMES OF UNCERTAINTY AND VOLATILITY - Part 4 OTHER IMPORTANT CONSIDERATIONS

Guest post by: Barry Lizmore

Article Overview: This is the final article in the four part series on investing in times of uncetainty and volatility. This article discusses your personal risk profile. What is the risk/reward trade off that you are willing to accept? We also discuss your investment time frame as this has an important bearing on how much volatility you can take on. Finally, we examine the importance of having a diversified portfolio and of receiving good unbiased financial advice from a qualified professional.

INVESTING IN TIMES OF UNCERTAINTY AND VOLATILITY - Part 4 OTHER IMPORTANT CONSIDERATIONS

What is your risk profile?

If you find the ups and downs of a balanced or growth portfolio to be too volatile and are losing sleep from the share market there is a possibility that you are in the wrong long-term investment option for your risk profile. Prior to November 2007 most share markets had several years of 20% plus returns. Everyone wanted to be a growth investor during this time. It is often not until there has been a major share market correction that you discover the level of volatility that you are comfortable with.

You must educate yourself on what is the expected investment return and volatility to be received from your investment option or portfolio. For example, the balanced option of a large well known Australian superannuation fund is expected to have a negative return one year in every4.2 years with a 95% certainty of future returns in a year between negative 15.26% and positive 32.14%. The long-term investment returns objective is CPI plus 4%. This is the risk/return trade off. Are you comfortable with this trade off?

The stable investment option in this same superannuation fund, which has less growth assets and more cash and fixed interest, is expected to be negative one year in every6.96 years with a 95% certainty of future returns in a year between negative 6.82% and positive 22.33%. The long-term returns objective is CPI plus 3%. The risk/return trade off is different because of the higher amount of cash and fixed interest.

If you are more comfortable with the stable option and accept the lower long-term investment return in exchange for reduced investment uncertainty and volatility then it is a valid decision to switch into the more defensive option. You may wish to reduce the timing risk by dollar cost averaging into your preferred long-term option. But be careful that you do not move back into the higher volatility option when the share markets have improved!

What is your time frame?

Understanding your proper long-term risk profile is important however it is equally important to understand the time frame of your investment option. You must invest short-term for short-term needs and long-term for long-term needs. For example, if you require money to buy a property next year you should not be invested in growth assets as there is a risk that the capital may be less than what you have invested.

Each investment option has a minimum investment time frame. Therefore it may be appropriate to switch your investment into a lower volatile investment option if your time frame has changed. This decision however is independent of market volatility and uncertainty. Your long-term objectives may still be funded by higher growth investment options as long as your risk profile is appropriate.

Be aware that if you are approaching retirement you should not necessarily be in a lower risk option. A male at age 65 still has a life expectancy of 18.54 years. Unless you have a large account balance at retirement you may face longevity risk, the risk that you outlive your money. Therefore it may be necessary for at least part of your money to be exposed to growth assets.

Are you invested in a quality diversified portfolio?

As previously mentioned, the market values financial assets at different prices for various reasons. If the share market has fallen it does not mean that you have lost money. You have only lost money if you cash out or switch into a cash based investment option and crystallized what is a paper loss. The long-term earning potential and value of quality assets have not changed and the market will eventually recognise this value.

Your situation may be quite different if you have a portfolio that is not diversified or have assets of questionable value. In that case you may be advised to "cash out" and accept the loss. For example, if you had a well managed Australian share fund, which typically has 50 or more different shares across various industries, you would have done very well in the four or five years previous to the GFC and would have recovered to some extent after the recovery. On the other hand, if your portfolio was limited to three shares, such as ABC Learning Centres, Allco Finance and MFS, you would have fared very badly as all companies have now disappeared.

Are you getting proper advice?

Self education on financial matters is important. This discussion is about self education however personal advice is necessary to ensure that you are making the right decisions. A suitable qualified professional will work with you to confirm your risk profile, your investment time frame for your various goals and advising on a quality diversified investment portfolio.

Self education is to understand what is financial planning advice, the advice process, the questions to ask your adviser, how to know if you are getting good advice and what to do if things go wrong. It also helps you to decide how much you can do yourself.

This is a reprinted summary from an article in my web site.

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Article Tags: investment, market, risk, self education, share market, volatile, volatility
Referred by: www.robbourne.com.au



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