Everyone is different and when it comes to investing, some people find themselves tossing and turning in bed, while others sleep easy. As an investor or super fund member, the key to getting a good night’s rest is to pick the investments (or investment options in your super fund) that match your personal risk profile.
Risk profiling is a simple tool used to categorise where you fit on the risk-taking spectrum. Some people are natural risk-takers, while others are not. Some people are very comfortable placing their money in higher risk investments so they have the opportunity to generate a higher return, while others are more conservative and cannot stand the thought of losing money. Neither investment choice is right or wrong; it just needs to be the right one for you.
Successful investing is a risk decision
Successful investing means being comfortable with the level of risk that accompanies the investment you choose. If you choose a lower risk investment (or a lower-risk investment option in your super fund), such an investment will usually provide relatively consistent, but lower returns over time. If you are seeking higher returns and you invest in higher risk assets, you are likely to see more volatility (that is, ups and downs) in your investment returns and a greater chance of a negative return (or a loss).
If you understand your risk profile, you then can know how much uncertainty you can easily accept when it comes to investment returns, and your level of tolerance in experiencing a negative investment return from time to time.
Tip: If you have a partner, it’s important to check his or her risk tolerance or profile too, as it may be very different to your own. When you are investing jointly or planning your family’s finances, you need to select a risk tolerance level where you can both sleep at night.
Understand your risk tolerance
Your capacity to tolerate risk affects most of the financial decisions you make, whether you’re selecting a fixed or variable interest rate on your home loan, or deciding whether or not to purchase an investment property or other type of investment. How you feel about financial risk depends on a range of factors:
- Personal goals
- Financial position
- Investment experience
- Timeframe for investing
- Comfort with volatility
Financial advisers use tools like detailed questionnaires, life-cycle analysis and sensitivity analysis to place you into a specific risk profile category. To work out your risk profile, the financial adviser will ask you to choose from a range of answers in response to questions like these:
- What is your major investment objective? – For example, maintain the security of my investments with regular income to live on, or maximise the growth of my investments.
- How would you react if your investments declined in value by 20% in one year? – For example, withdraw all my money immediately and move them to bank deposits, or increase the amount invested because the market is cheaper.
Once your attitude to risk is identified, the financial adviser can determine which investments (for example, shares or term deposits, or a combination of assets) are most suitable to use to achieve your financial objectives while still allowing you to feel comfortable with your investment choices.
Tip: It’s worth revisiting your risk profile every few years, as most people’s attitude to risk shifts as their circumstances change. For example, once you begin paying off a mortgage, you’re likely to be less comfortable taking on more financial risk than when you had smaller financial commitments.
Age has an impact as well, with many people finding they become less comfortable with financial risks as they get older. Feeling uncomfortable about your investments could indicate your risk profile has changed.
Risk profiles: what they look like
There are no standard risk profiles used across the financial advice and investment industry, but the categories are usually based on the percentage allocated to ‘growth’ assets relative to ‘defensive’ assets. Generally, the higher the proportion of growth assets, the riskier the investment becomes and the greater the potential return in the long-term. Common risk profiles and asset allocations are set out in the table below.
|Risk profile||Common allocation split for defensive and growth assets||Description|
|Conservative||95-100% defensive assets
|Not prepared to take any investment risk and willing to sacrifice higher returns to safeguard capital.|
|Cautious||70-90% defensive assets
10-30% growth assets
|Prepared to accept only a small amount of risk. Priority is to preserve capital over the medium to long-term.|
|Moderate / Moderately conservative||50-60% defensive assets
40-50% growth assets
|Can accept some short-term risk to capital to achieve longer-term capital gain.|
|Balanced / Assertive||30-40% defensive assets
60-70% growth assets
|Seeks consistent capital growth with some income to smooth returns. Suited to medium to long-term timeframe.|
|Aggressive / Moderately aggressive||15-25% defensive assets
75-85% growth assets
|Understands investment market moves and is happy to sacrifice short-term safety to maximise long-term capital growth.|
|Highly aggressive / Aggressive||95-100% growth assets||Strong emphasis on maximising long-term capital growth. Able to handle short-term fluctuations in values and greater chance of capital loss.|
Source: Table compiled by the author based on common profiles and asset allocations used by various super funds and investment companies.
Super and your risk profile
Knowing your tolerance for risk when investing and understanding how it influences the investments you will be comfortable with is very important when it comes to selecting the right investment option for your super account.
Some experts even suggest having two risk profiles: one for your super and another one for your investments outside super. The reason some experts suggest this approach is because your super account will be invested for a much longer time (up to 30-40 years), compared with most of your other investments (potentially only five to 10 years, and possibly longer especially if you have property investments).
Your super fund will offer a selection of pre-mixed investment options and these options will range from conservative, defensive funds through to aggressive, growth-style investment options. Having an assortment of investment options means you can choose one that closely matches your tolerance towards risk.
You may belong to a super fund that also offers the option to invest in individual asset classes, such as an option to invest in a managed Australian share portfolio. Your super fund may even give you the option to have direct investments in assets such as term deposits or Australian shares (directly or via exchanged traded funds or listed investment companies). If you are considering such options, then understanding your risk profile becomes even more important.
Most large super funds have detailed information about the risk level, suitable investment time period and type of investor best suited to each of the investment options offered by the super fund. If you need more information about your super fund’s investment options, check out your super fund’s Investment Choice brochure or phone its member information line.
For more information about investment options, see the following SuperGuide articles:
- Investment performance: Assess your super fund in 4 steps
- Super control: how to switch your super account’s investment option
- Investment returns after retirement: Understanding the 10/30/60 Rule
- Investment-performance: we’re the best super fund. No we’re the best
- Asset classes: Naming the investment winners for the 2016/2017 financial year (and previous years)
For more information about financial advice, see the following SuperGuide articles:
- Financial freedom: Retirement planning in six steps
- Seeking financial advice? A 5-step guide to obtaining expert help
- Seeking advice? Financial Advisers Register is a starting point
- Help! How can we find independent financial advice?
- Financial advice: Only 101 independent financial advisers in Australia
- Financial advice guide: What to expect when you talk to an adviser
- SMSF advice: Is your accountant still allowed to help your fund
- Six dangers when seeking financial advice
- How many financial advisers operate in Australia?
- Free retirement planning assistance now available
- Cheap financial advice available from super funds
- Financial advice for super: Is it worth the money?
- Problem with your adviser or super-fund? A 2-step plan to resolve it!