Why Risk Profiling Is Not The Answer To Successful Investing
We are again in a Bear market (returns down over 20%). Stock markets worldwide have plummeted, and the doomsayers are everywhere. It’s a tough time for investors. Many are indecisive on what they should do, especially if they do not understand their investing approach.
Lifestyle Financial Planning differs from traditional financial advice and investing in many ways, one of which is how “risk” is interpreted and viewed.
The Problems With The Traditional Approach
In the traditional approach, your adviser will ask you to answer questions. These are about how you feel about financial loss or ask you to complete a risk analysis questionnaire. They might also classify you according to your age. Either way, you will have a high, medium or low-risk profile. Of course, one’s past experiences (emotion) would play a role in this.
The problem with this approach is that how you feel on a particular day determines the asset allocation to which your money will be exposed. For example, a high-risk profile would lead to an investment strategy with high equity (shares) exposure. In contrast, a low-risk profile would mean less equity and more cash, property, and bonds. This asset allocation would determine the long-term return on your funds. This results in how much you will have at a certain point. If, for example, the reason for saving was retirement, then your lifestyle at that point would be determined by this approach to investing.
Understanding Lifestyle Financial Planning
Lifestyle Financial Planning takes a different approach to this traditional method by first looking at your lifestyle. This means understanding the current cost of how you live. This is derived from monthly and annual expenses to future goals and dreams that you want for yourself and your family. These all get costed. They are then compared to your existing and future savings to determine the return you need to achieve what you want.
Once we understand the return needed on your funds over time, we can match the asset allocation that will deliver this result. This asset allocation will attract a level of volatility which we can illustrate to you. Should you not be comfortable with it, we will help you understand the trade-offs that you need to consider for your plan to work.
The LFP approach looks at what you actually need and what is possible. This is in contrast to just categorising you according to your age or how you feel on a certain day. In addition, proper financial education on your long-term investment strategy can help you control and understand your emotions. This helps when we go through challenging market conditions as we are now.