How to Diversify Your Investment Portfolio for Risk Tolerance

asset accumulation

Are you looking to build up your Investment portfolio?

Let’s face it. If you are serious about creating wealth for retirement you want to accumulate as many assets as you can.  Over time these assets may grow or provide income depending on what your long term retirement plan is. An important consideration in the Asset Accumulation stage is Investment Planning and part of that function is to accurately define Diversification and Risk as it applies to your individual situation.

Follow along as we explore what Diversity and Risk tolerance means for you.

Diversify

The term Diversify means to spread, expand and differentiate. When we apply those meanings to an investment portfolio we do it with singular purpose. The concept of diversification is to make sure your investments are invested in areas that are different from each other to minimise the risk of losses in case one asset class suffers a downturn.  The old saying about putting all your eggs in one basket applies to diversification.  So rather than putting everything into Australian shares, you could diversify by opting for some overseas shares as well. Within that asset class you could look at different industries and identify their drivers so any disruptions to a particular industry doesn’t result in losses to all of your investments. Of course, if you have shares you can diversify by changing asset classes such as direct property. Even property can be diversified by type, postcode and price.

As important as diversity is, you also need to have a good understanding of how risk averse you are.

There is a direct connection between risk and return so your attitude to risk will affect the returns you achieve. That doesn’t mean you should start taking risky investments to chase a high return, it simply means that you should invest in areas that you are comfortable in.  The level of risk you are willing to accept determines your risk tolerance.

Risk Tolerance

The bottom line to knowing your Risk Tolerance is to make investing comfortable. We’re sure you will agree that feeling safe about what your money is invested in goes a long way towards peace of mind. Besides, feeling safe will give you confidence to continue to invest when the level of risk that you will lose some or all of your money is within your tolerance level.

Risk tolerance also depends on your ability to cope with dips in the value of your investments. Various factors can influence your risk tolerance such as your age, your health and your perceived ability to recover from any capital losses. If you are not sure where you might be on a risk tolerance level, just ask yourself this particular question –“How would I feel if my investments dropped 20% in value overnight?”

If this drop would cause you to worry a lot and pull out of the investment, then a high risk investment is probably not for you. This is mainly because taking this sort of action just crystalizes your losses. However, if a drop in the market causes you to start looking for bargains then you are probably very comfortable with fluctuations in the market. A higher level of investment risk is something you can live with. As an individual, your comfort level might be somewhere in between those two extremes.

You should also take into consideration that your partner may not have the same risk tolerance level you do. So, if you are considering a joint investment, you may have to compromise so you are both comfortable.

Your overall risk tolerance then is the lesser of the risk you are comfortable with and the risk your timeframe will allow you to take. Understanding where you sit will make choosing investments much easier. For example, growth assets can be considered high risk while Cash is low risk.

The simple fact is that the longer you have to invest the better off you are to make up for any losses. A short timeframe for investing is riskier because you have less time left to invest.

So we can safely say it’s the dips in the market that may cause the most concern but in reality, the length of time you have left in your working life to recover from those dips by continuing to invest is the key.

Positioning your investments to reflect your risk tolerance, with regard to the time left to invest is a must to make the most of your returns within your comfort level.

It’s this balance between risk and return that is the hardest to achieve. That’s why Investment Planning is crucial to make sure you are invested in the asset classes that reflect your preferences.

It’s also wise to revisit your investments regularly to make sure your original parameters are still represented because the assets actual performance over time may skew the balance of the portfolio one way or the other.

No matter which way you look at it, Investment Planning is something to embrace regardless of where you are in your investing life. Why not make an appointment with one of our experienced Planners today?

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