What degree of risk are you comfortable with?

Whether an investment is suitable for you must take into account all of your circumstances and objectives. In particular, the timescale for investment, whether the objective is income or growth, and your age. The most difficult is matching the investment to your attitude to risk, and that is what we focus on here.

Far too many investors jump straight into buying investments without considering if risk investments are right for them.

One commentator said “Human beings are not cut out to be natural investors”, and this is an uncomfortable truth for many of us. Millions of years of evolution have given us a brain that can instantly process visual images, assess threats, develop language and (sometimes?) make informed choices given sufficient information.

But those millions of years of evolution have not enabled the development of the ability to invest rationally. Some say this is because financial markets are a relatively new hunting ground, and given another few hundred thousand years we may get better at it. Others tell us it is to do with our unconscious impulse to herd (i.e. if everyone else is buying we want to play too), and once in a crowd an ordinarily rational person has a tendency to irrationality (which is why we get investment bubbles).

Whatever the reason, because of our inherent inability to invest rationally, it is vital that we construct (in one of our rational moments) a sound framework within which we deal with risk investments from year to year. For most investors that means using some kind of review service like ours - so when the rest of the investment world is losing its head, you don’t lose yours and a large chunk of your investment capital.

Before considering risk in more detail, we should remind ourselves that the stockmarket does offer the opportunity for superb long term rewards – the sharp falls from 2000-2003 are not representative of the long term - see more in section 3.2. Even so you must understand that these rewards are available because you take on risk - risk and reward go hand in hand.

What degree of risk are you comfortable with?

There is no perfect way to assess this. Asking this question of yourself in a void (without also having some understanding of investment risk and history) is of limited or no value. A sensible way to proceed would be:

Ask yourself questions about your attitude to risk

Inform yourself about investment risk

Understand investment risk attaching to funds

And at the end re-check your answers to "Ask yourself questions about your attitude to risk", as you may feel more or less happy about risk having gone through the whole process.

Thank you for your prompt comprehensive reply - even if it was telling me the 'not so good news'. ...
[read more]