Are you willing to take risks?
In our “Basics” section we have seen that every investment bears a certain level of risk. While some risks can be limited by making certain investment choices, most other investment risks cannot be avoided.
First of all, there is a risk that the money you invest decreases, if future inflation is higher than the return you earn on your investment.
There is also a risk that the bank you entrust your money to gets into trouble and is not able to reimburse the money you have deposited. Another risk is that you may lose the money you have invested if the company you have invested in goes out of business.
These are just some risks associated with investment and the chance that they happen may be high or low, but they are always present and should be considered before you invest.
It is important to understand that in order to attract investors, projects and investments with higher risks must offer the possibility of achieving higher financial rewards. In other words, this means that investors seeking higher financial rewards have to accept higher financial risks.
Before taking any investment decision, you should therefore ask yourself if you are ready to accept certain risks in order to have the possibility of a higher return.
The most important question you should ask yourself is: Can I afford to lose some, or even the entire amount of the money I invest if my investment isn’t able to offer the financial rewards I expect?
In order to answer this question you have to carefully analyse your personal and financial situation. In other words, you have to define your investor profile. When you go to your bank or other professional adviser for investment advice, that’s exactly what the adviser will help you do.
Your investor profile: your guide when investing
If you don’t seek professional advice before you invest your money, it’s even more important to do this exercise on your own, by asking yourself and writing down the answers to a series of basic questions. For example:
What are my investment goals? Do I just want to preserve the amount of money I invest at the start, or do I want to make my money grow over time? Should my investment provide me with regular income?
What is my investment horizon? In other words, when do I need the money I invest today? Do I need it to build a house in three years’ time? Do I need it to finance the university studies of my children in 15 years? Or do I need it to maintain my standard of living when I retire, in 30 years or more?
Depending on your age, current stage of life, family commitments and financial situation, you will have different answers to these questions. Your answers, as well as your experience with investing and how much you know about financial products, define your investor profile.
Your investor profile will guide you when choosing your investment strategy. It will help you to avoid entering into investments that are not appropriate to your personal situation.
A key element: Your investment horizon
If you can afford to lose some money and if your investment horizon is quite long, you can invest in some more risky investments, which may provide a higher return, like stocks for example. Higher-risk investments tend to have prices that move up and down more often and it may take a longer time for the financial rewards to materialise.
However, if your investment horizon is quite short or if your target date is very specific, you should focus on investment products that provide you with regular income, like bank deposits or investments that hold bonds.
Of course, the reality is that you will probably have both short and long term financial goals and that these goals will change as you move through various stages of life. Therefore you will likely adopt a mixed approach by investing some of your money in safer, lower-risk investments with a focus on capital preservation, and by allocating some money you don’t need immediately to riskier investments in order to achieve your longer term financial goals.
The art of financial planning is to find the right mix and you should not hesitate to seek help from financial advisers. These qualified professionals are trained in understanding your investor profile and financial needs, as well as drawing up financial plans and recommending where and how to invest your money.