If you are worried about your investments right now have you stopped to consider whether you are using the right risk profiles?
When we talk about investment risk we are not talking about the risk of losing money. That will never happen unless you are invested in something unregulated and dodgy. We are actually talking about the daily ups and downs in the value of your investment.
In the profession this is known as ‘volatility’.
Using the right risk profiles can mean not only achieving your investment goals but also doing it in a way that is less volatile.
What are risk profiles and why do we need them?
If we look back over the last 100 years plus the asset that has produced the best returns has been equities (stocks and shares).
So in theory we should all be invested 100% in shares as based on past performance this will give us the best return.
The problem is that equities do not go up in a straight line. Sometimes the line can drop far and fast like we have recently seen with the impact of the coronavirus.
In fact, between 1935 and 2018 the main US stock market index the S&P 500 has seen 4,563 days of price movements positive and negative of 1%. There were 1,094 days of 2% price movements.
This means roughly a 1% price swing every trading week and a 2% price swing every trading month.
But over the same timeframe the S&P actually increased by 25,290%!
It’s the swings that make the investing journey hard and does not go well with our natural human instincts. Investors typically do not get the fall value of their investment return. The reason. They sell when things look bad (selling cheap) and buy when things look good (buying expensive).
So the idea of risk profiles is to try and smooth out the return you get from investing. The way they do this is by diversifying your investment portfolio and using different assets (stocks, property, bonds and cash).
For example, during some market conditions (like what we are seeing with Coronavirus), equities fall but bonds rise.
Most investments firms will use some sort of risk scale to give you an idea of how their funds may work. For some firms the scale is 1-10 (1 being lowest risk and 10 being highest). For others they use descriptions like low, medium or high.
The idea is that a risk level 2 fund should give you better returns than a risk level 1 fund, and a risk level 3 fund should give you better returns than a risk level 2 fund and so on.
Also a risk level 2 fund should be less volatile than a risk level 3 fund and a risk level 1 fund should be less volatile than a risk level 2 fund and so on.
Do risk profiles actually work especially when everything goes down?
There are certain times when the stock market crashes. We have seen this very recently as the Coronavirus shocks the world.
During these times nearly every asset falls in value and some people believe that risk profiles are pointless.
This is just not true. Remember the point of risk profiles is not to guarantee a return or guarantee no loss. They just limit the volatility depending on the risk profile selected. This is where risk profiles most definitely work.
The chart below shows the market sorted into an aggressive (high risk), balanced (medium risk) and cautious (low risk) portfolio.
Over the last 10 years we can see that over the longer term the higher the risk profile the better performing the investment.
Turning to the recent stock market crash (the last 3 months).
We can see that with the same risk profiles the situation is reversed. Volatility has been less the lower the risk profile.
So the key is to know the right risk profiles for you. This will depend on what return you require and how long you have to invest.
Our own RTS Investment Strategy has performed exactly as we have planned with performance and volatility following the appropriate level of risk. In fact, because we make subtle tweaks to the asset allocation to take advantage of certain market conditions the returns have been far superior compared to the market average.
If you would like your current portfolio assessed to see how it compares and would like more information on the RTS Investment Strategy then why not take advantage of our free 15-minute call. You can speak to a Chartered Financial Planner who will listen to your situation, give you an outline of what you need to consider and guide you in the right direction.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.