When constructing an effective investment game plan, investors should analyse
their personal investment profiles before making any commitments. Different investors
tend to have different investment profiles. Therefore, it is vital that you identify
your own characteristics before investing.
Risk tolerance is the most important criteria in analysing one's investment profile.
Each individual has his or her own "personality" in terms of risk tolerance.
There are some people who have high risk tolerance and are willing to take on a higher
degree of risks while there are some investors who prefer to be purely conservative
when investing their hard-earned money.
How can tolerance be measured? Try putting yourself in the following possible
scenarios;
Scenario 1
You have invested some money and incur a loss of less than 5% after one-year period.
Scenario 2
You have invested some money and incur a loss of 15% after one-year period.
Scenario 3
You have invested some money and incur a loss in excess of 20% after one-year
period.
Generally, investors who cannot withstand the loss in scenario 1 is likely to
have low risk tolerance. This group of people definitely avoid volatile investments
such as stocks. Their portfolio will usually comprise of fixed-income instruments.
Investors who can still sleep well in scenario 2 will more likely have a moderate
risk tolerance and would prefer a more balanced portfolio. Investors who can tolerate
the loss in scenario 3 are termed as the more aggressive type and they are more likely
to be attracted to pure equity-driven portfolio concentrating on smaller companies
in particular.
An individual's investment plan should be tailored to his or her own personal
investment profile. The amount of risk that an investor is willing to take on is
an important factor before he or she makes the ultimate decision to invest.
Taking on too much risk can be detrimental if the risks are not properly managed.
Since any form of investment concerns returns and risks, it is important for you
to analyse your risk tolerance well and to try to balance between the risk and the
kind of return that you expect.
Risk is the possibility that an investment will not meet the eventual investment
goal - expected return. Regardless of your investment selection, there is always
a probability that your investment's return at the end of the investment period will
be different from what is expected.
Every investor wants the highest assured return possible but in reality, there
is no such investment available which offers high return on a consistent basis while
fully protecting your investment capital. Investors should understand the risk-return
dimension and that there are a number of tradeoffs that have to be remembered.
Firstly, high returns come with high risks (positive relationship). Secondly,
an investment which delivers a very high level of return tends to lack consistency
as compared to another form of investment that is designed to maximise your capital
protection thus offering lower returns.
