For some, investing money may be daunting but in the current low rate environment it is a way to make your money work harder for you and should be looked at as a long-term journey. Being prepared is key towards maximising the potential outcome of your investment.
My contribution aims to help readers prepare for this journey and take the necessary steps towards successfully achieving their financial goals.
Assess your risk tolerance
Risk tolerance is the ability of an individual to endure the variability of investment returns. We are all individuals and have different backgrounds, lifestyles and attitudes towards investment risk. Across the spectrum, while some of us would not be willing to take any risks or withstand losses, some of us might be willing to take some risks but would tend towards avoiding exposure to high levels of price fluctuations, which is termed as volatility.
Assessing your tolerance to risk and deciding on the most suitable asset allocation in line with your risk tolerance is crucial to ensure that the first step you take is the right one.
So how do you gauge risk tolerance? Start by determining your investment horizon.
Generally, the longer your investment horizon, the higher the risk you can take because you can afford the time to last a market cycle, that would typically include periods of growth and declines, helping smooth out short-term volatility.
On the contrary, the shorter the investment period, the lower the risk one can take, as you would not have the time to recover losses if your investments suffer from a sudden decrease in value.
Besides, your risk tolerance is dependent on your life goals. Do you need to set aside funds for your children’s education? Are you going to buy a property in the near future? Are you interested in saving to buy a new car? All such factors will have an impact on your investment decision.
Diversify your investment
Balancing risk and return is the key to long-term investment. There are ups and downs in all economic cycles and even investment experts find it hard to predict the performances of all asset classes. Asset classes are groups of investments, such as equities, bonds and cash.
The same asset class will not always perform the same way during different investment cycles. For example, the best-performing asset class one year may change in the next and therefore no particular asset class can be an all-time winner.
Investors should carefully allocate their investments across different asset classes, economic sectors and geographies. This is called diversification. To make diversification work, an investment portfolio should include assets that are complementary and tend to react differently to the same economic conditions. More precisely, some negative elements in the market might cause an asset class to decline sharply, but pose little threats to another. In the world of investments, such pairs are called lowly-correlated assets; put simply as one asset class increases in value, the other decreases. Done wisely, such asset class mix can effectively balance the risk and return of an investment portfolio.
Have a plan for asset allocation
This is where it all starts tying up. Once you have identified your tolerance to risk, set your investment targets and allocate your cash into a portfolio of different asset classes. The idea of asset allocation is to include equities, bonds, cash and other investment tools, since different investment vehicles come with different risk-return profiles. Generally, the higher the potential return of an asset class, the higher the risks it carries.
Assess investment performance
A well calibrated investment portfolio can help investors reach investment goals progressively. During the course of the investment journey, economic situations and financial events can (and will) affect the market. The fundamentals of each and every industry will also change, bringing varying impacts on different asset classes within a portfolio.
For instance, central banks from around the world take action to control the money supply from time to time. The change in the interest rate trajectory will affect the prices of equity, bonds, and other instruments to varying degrees. When the economic environment and market conditions change, those expected to perform handsomely might turn out to become laggards, and vice versa.
It is therefore important to assess the performance of your portfolio against your investment goals regularly. Just like a medical check-up – only through regular assessments can the well-being of a portfolio be known and whether it is on track to meet expectations.
Rebalance your investment portfolio
Understanding the importance of asset allocation is essential, so failing to maintain the set allocation may result in being unable to realise long-term goals.
The proportions of different assets within a portfolio change over time as their prices tend to move. For instance, during a period where the price of equities will rise (which may also be known as a ‘bull run’) those for other asset classes might stay stable or even drop. Such instances may tilt the weighting of the portfolio towards equities, increase its associated risks, and cause deviations from the original investment strategy.
If no adjustments are made, the balance between different assets will be lost, undercutting the ability of the portfolio to meet its original objectives. The key to long-term investment is therefore to rebalance the portfolio regularly. Only through making adjustments can the risk levels and investment goals of a portfolio be aligned.
Your trusted financial planning advisor will be able to guide you from the start and walk with you through this journey, every step of the way.
Interested in learning more about the investment world? Visit our Investment Academy https://www.assetmanagement.hsbc.com.mt/en/individual-investor/investor-resources/investment-academy
Konrad Borg Myatt, CEO, HSBC Global Asset Management (Malta) Limited