What kind of investor are you?

   

Your investment profile

Your investment profile will define what type of investor you are. Your profile is created by taking into account age, financial circumstances, investment goals and, most importantly, how much risk you feel comfortable taking or can afford to take. Risk is a vital element because the more risk you can accept, the higher the potential returns you might make from your investments. These factors, together with issues such as tax and liquidity (the speed with which you can access your money or cash in assets if needed), will all help shape your investment profile. Your financial advisor can help you establish your investment profile.

A clearly defined investment profile will help you find investment solutions that meet your needs. Younger investors investing for their retirement several decades in the future can afford to take greater risks with their money in order to achieve potentially higher rewards. They can invest over the long term and are better placed to ride out the ups and downs of the market. Investors nearing retirement, however, may be better advised to favour less volatile, if also lower yielding, assets in order to reduce the risk of a sudden decline in the total value of the investments.

Investor profiles generally fall into three high-level categories:

Cautious (low risk)

Capital growth is not a priority and cautious investors seek stable investments that will grow in value gradually and are not vulnerable to high volatility. With the majority of assets invested in bonds and cash instruments, a cautious portfolio should deliver a steady income stream and moderate capital growth.

Balanced (medium risk)

With a more volatile asset mix, investors can expect good if perhaps not exceptional capital growth over the long term. They will experience some market fluctuations but probably not a rollercoaster ride under normal market conditions. Underlying assets are likely to include a mix of shares and bonds from stable companies. A small proportion of the assets of a balanced fund may be invested in riskier equities in order to deliver better capital growth.

Aggressive (high risk)

Aggressive investors are prepared to expose funds to greater risk and are comfortable with volatility in order to maximise capital growth. Their assets may include equities from emerging markets and investments in start-ups, and will generally comprise a significantly higher proportion of shares than bonds.

Risk, investment performance and volatility

Investors' attitudes toward risk are central to the way they make investment decisions. It will strongly influence not just their likelihood of losing money but the extent of the returns their investments are likely to generate. For most investors the term 'risk' focuses primarily on the possibility that their investments might either incur a loss ('downside risk') or fail to make a profit ('upside risk'). A key question that investors must ask themselves is how they might respond to an unexpected fall in the value of their investments. Only then can they take decisions on investments that match their risk comfort levels.

Risk and volatility

Risk is often viewed and measured as the level of price volatility an asset or investment fund experiences - the range within which its price fluctuates. Short-term investors may find volatility a greater risk than those investing for the long term because under normal market conditions, price fluctuations should eventually balance themselves out.

The volatility of an investment fund's value will reflect that of the assets in which it invests. An examination of the fund's prospectus may demonstrate how volatile a fund has been in the past - although this is never a certain indication of how the fund may perform in the future. What it may show is whether growth has come amid rapid fluctuations in price or whether the growth has been more steady and incremental, with few if any downward tacks. Two funds may deliver the same level of capital growth and income but have taken very different routes, and experienced vastly different volatility, to achieve the same goal.

Volatility can come from a number of different sources, including fluctuations in the price of a particular share or shares, or of the currency in which the price is measured. Highly-focused investment funds may experience greater volatility because they contain fewer investments, so the performance of a single investment may have a greater impact on the fund as a whole. However, it's important to remember that volatility can also be positive because it can bring greater returns as well as greater risk.

Return and performance

The return of investment funds is made up of growth in the value of the fund's assets plus any income it may distribute to shareholders (for many funds income is reinvested in additional assets). The fund's performance is measured by the return it delivers over a particular time period. The performance can be compared with that of similar funds, or with a benchmark such as a stock market index. Investors can look at historical information about a fund's performance to decide whether it is likely to meet their targets for return, although past performance is no guarantee that those returns will be repeated in the future.

Risk and return

Risk is an essential part of investing - because without risk there can be little or no return on your investment. Being willing to accept a higher the level of risk often means that investors can achieve a greater potential return on their investments. By contrast, investment funds that invest in less risky assets are likely to deliver lower returns.

Shares that have high growth potential may also carry the risk of substantial losses. Both the potential return and the risk should be less for shares of established companies that deliver steady growth and returns. However, in investment funds the overall level of risk is carefully managed. Fund managers operate within established risk limits to ensure that the risk and return targets are what investors expect - although there can never be a guarantee that market movements will not have unforeseen consequences for the fund's investments.

Diversification is a key tool in managing risk. Investing in a wide variety of assets spreads the risk in each investment across and between sectors, markets, countries and regions, etc. The degree of diversification within a fund is tailored to meet its performance objectives. Risk management is an integral part of the investment process as fund managers seek to ensure that the assets they invest in will meet the fund's performance objectives.

Details of a fund's expected levels of risk exposure and return objective will be explained in the fund's prospectus.

Investment life cycle

Setting financial goals will help you develop an appropriate investment strategy. While for most people the single most important long-term goal is having enough money for retirement, many investors set holidays, home improvements, education, business ventures and luxury items as investment goals. One purpose that does not fall within a particular time frame is creating an emergency fund for life's unexpected twists and turns. Choosing a flexible type of investment allows investors to increase periodic contributions when they have more disposable income and cut back if times are more difficult. Instant access is an essential component of any emergency fund.

An enormous influence on choosing investment funds is your age and investment profile. Needs and goals change significantly over the years. At the start of your career you may be saving for a deposit on a mortgage or car - you may not have much disposable income to spare, but your expenditure will also probably be low. As you get older and approach the peak of your earning power, you may well have a mortgage to pay and a family to support, but also have the ability to make additional investments for other goals you wish to achieve. As you approach retirement, your financial commitments and priorities will shift once again as the desire for regular income becomes more important than the need for strong capital growth.

As your financial landscape changes it is important to ensure that your investments change also to reflect your revised investment needs. A regular investment review with your financial advisor will ensure that your portfolio remains in line with your circumstances and requirements.

Retirement planning

For most people, planning for their retirement is the most important reason for saving and investment. Ideally this should be spread over your working life. If you start saving for retirement early in your working career, your investments are less vulnerable to the ups and downs of the market cycle. Long-term investing also allows you to benefit from share cost averaging - investing regular amounts steadily over the long term, for instance several decades, reduces or avoids any need to worry about buying assets expensively at the peak of a market boom, because they will be matched by others bought cheaply when prices are depressed.

Investment funds are a useful tool for retirement planning because of their diversity, flexibility and liquidity. Funds can be bought and sold easily, without high costs and at fairly short notice. The vast choice of funds available in the European market (a large proportion of them set up in Luxembourg) allows you to build a portfolio of investments with varying degrees of risk and return. Over the retirement saving period, the degree of risk and return in the investor's portfolio can be adjusted to match their changing profile and life stage.

In general, financial advisors recommend that when you are young, you should invest in a greater proportion of aggressive assets that carry a higher risk but promise higher returns. Later on as you approach retirement your portfolio should become more cautious. This should minimise the risk of market disruption significantly reducing your pool of money available to use in retirement. As you reach retirement age investors may want to switch part of their portfolio into investment funds that pay out dividends from shares or interest on bonds. This should provide a regular income stream at a time when you are no longer earning a full salary.

A popular way of investing in investment funds for retirement is through self-invested pension schemes or through unit-linked life insurance schemes, for which Luxembourg is also a European leader. The ultimate value of unit-linked life policies depends upon the investment funds in which it invests, which are in many cases identical to well-known stand-alone funds but reserved for life insurance policyholders. Unlike with standard investment funds, there are usually restrictions on investors' ability to cash in life policy or pension scheme assets before reaching retirement age, and sometimes financial penalties. You should always take professional advice, including advice on your tax position, before investing through pension schemes or life policies.

Rules and tax arrangements for investments made as part of a retirement income scheme vary greatly according to the investor's country of residence. In some cases investments benefit from tax breaks but the eventual income in retirement is taxed, in other countries it is the other way round. However, in general investments made as part of an approved retirement planning scheme benefit from some form of tax benefit, whether when making an initial investment, during the period of growth in your investments, or when you take your benefit.

Updated on  
Share |