When it comes to investments, the link between risk and reward is hard to break. If you want decent returns, you’re going to have to take risks – but how much can you tolerate?
“The most important part of investing is starting in a way that feels right and comfortable for you,” says Helena McGonigle, a financial planning specialist with AIB.
“It’s also important to take a holistic view of your finances rather than looking at any investment in isolation. Having a solid safety net is essential, which usually means having sufficient funds to cover three to six months of essential expenses. Once this in place, we help customers to identify their goals and discuss their ability to save towards them to ensure any plan is realistic for them.”
For goals that are five, 10, or 15 years away, investment may be a good option to consider.
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“To help with this, we offer advice either through a financial adviser or digitally via the AIB Life Hub on the AIB app. Both channels use the same process – a short risk appetite questionnaire that asks straightforward questions about your financial situation, goals, sustainability preferences, and general attitude to risk,” she explains. Once your risk profile is established, you can choose from a wide range of funds with different levels of risk, making it easier to find an option that matches your comfort level and investment goals.
Understanding the relationship between risk and return is key, says Fergus Moyles, head of private wealth strategy at Mercer Ireland.
“Clients often want to achieve five per cent returns on their investment but also want their capital guaranteed. However, to achieve medium or high returns, you need to invest in more volatile growth assets such as equities – shares in companies – or even property,” says Moyles.
“It is also important to understand that investment returns are not always on a linear upward trajectory. There will be ups and downs along the way. Education is needed to understand the importance of picking a level of risk you are comfortable with and staying the course.”
You need to consider how long you are investing for as well. “If you have short-term goals and need the capital back in the next five years, investing in the markets may not be suitable. In this case, you might wish to look at less risky assets such as state savings or bank deposits. In contrast, if you are not looking to access the capital in the next five to seven years, you may have the tolerance to take on additional risk in your investments to achieve higher returns and protect your capital from the effects of inflation.”
Understanding your personal capacity for investment risk is critical. “This includes understanding your overall assets and financial position. You also need to consider your reliance on this investment as well as your likely emotional response to falling asset values,” adds Moyles.
Typically, the larger an investment is as a proportion of a person’s overall wealth, the greater the risk. Finding each individual’s risk-reward sweet spot is therefore important.
That means teasing out how a person is likely to feel if their investment were to fall by a certain amount, and how they might react to that, points out Daniel Moroney, investment strategist at wealth manager RBC Brewin Dolphin Ireland.
Accepting that volatility and risk are in some ways interchangeable helps. Often the temptation is to think only of the certainty that capital guarantees bring, without factoring in the corrosive impact of inflation over time.
Those who think they are being prudent and cautious with their life savings will, decades hence, “almost certainly find they have far less money than they would have had if they had embraced some volatility,” says Moroney.
If saving rather than investing is for you, at least by choosing carefully where to park your money you can at least try to outperform inflation.
“I would never put people off investing at all because it’s a very clever and prudent way to build wealth,” says Eoghan O’Hara of Raisin, an online platform that provides access to more than two dozen European banks via one account.
“But you also have to ask, how would I feel if I logged into my investment portfolio and saw a value had dropped by 10 per cent, for example. If it is going to cause you sleepless nights, then maybe a more conservative strategy might be best suited for you.”
On the other hand, learning to hold your nerve can pay dividends too.
Karl Rogers, chief investment officer at private market investment firm Elkstone, refers to Roger Federer’s commencement address to the Dartmouth College class of 2024 as elucidating a point worth remembering when it comes to risk tolerance.
In the address Federer told students, for which we might here read investors, that perfection is impossible. In tennis, he surely came close. Of the 1,526 singles matches Federer played in his career, he won almost 80 per cent.
“But what percentage of the points do you think I won in those matches?” he asked the students.
“Only 54 per cent. In other words, even top-ranked tennis players win barely more than half the points they play. When you lose every second point, on average, you learn not to dwell on every shot.”
Life is, he told students, “a rollercoaster”. Investing is too. Very often the ace in our game is to not let news of the latest stock market gyrations, so readily available on our phone, bounce us into knee-jerk reactions that only risk making the outcome worse for us over the long term. That risks being a double fault.
