Before you look at making an investment, it is important to know your investing profile and how much risk you can accept. Once you know your profile, you will be better able to select investments that let you make more money and sleep better.

To start, it is important to realise that any investment involves some risk.

Stocks may go up or down, for example, and property prices can fluctuate. There is even a risk, however small, that the bank that holds your savings account could go out of business.

Different people are willing to accept different levels of risk. Some investors are comfortable investing in high-risk high-return stocks where they could lose much of their investment, for example, while others wouldn’t possibly consider such risky investments and would sleep well only if their money is safer.

UOB Bank notes that whether you are a risk-averse or conservative or aggressive investor, selecting the right investments can get you closer to the returns you want while letting you be comfortable with the investment you select.  

Financial advisory firm Schroders similarly advises that understanding personal behaviours and motivations when investing is important in helping you make the right investment decisions, since each investment option has unique risks and potential rewards. 

It is also important to realise that your risk profile affects how much money you may accumulate, because there is an inverse relationship between risk and returns.

Aggressive investors who take more risk can earn higher returns over the longer term, while more conservative investors may give up some of the upside potential of their investments in order to avoid losing money.  

DETERMINING YOUR PROFILE

As you seek to establish your risk profile, National Australia Bank advises that you need to consider two key factors: Your “ability” to take on risk and your “willingness” to take on risk. “These do not always align,” it says.

Even though someone who has an emergency fund and other large investments has a higher ability to take risks, for example, they may still be risk-averse.

Your risk profile may also change over time, depending on your stage in life and your goals.

You may become more or less risk-averse, for example, as you move into a relationship, have children or reach other life-stage milestones. 

To figure out your risk profile, use online tools such as the Standard Life UK’s “Assess your attitude to investment risk” questionnaire, or the CalcXM risk tolerance questionnaire.

After answering questions about your investment goals, investment timeframe and ability to accept risk, you’ll receive input on whether you’re a conservative, moderate or aggressive investor.

You could also reflect on the level of risk you’re willing to take to achieve your goals, the level of losses you are willing to take and your overall tolerance for risk, then rate yourself as conservative, moderate or aggressive.

USING YOUR PROFILE TO CHOOSE INVESTMENTS

Working out your risk profile is the first step towards developing a diversified investment portfolio that you are comfortable with and crafting an investment plan.

You may then use your risk profile to select investments based on the level of risk you are comfortable with and your desired return.

If you’re a conservative investor, for example, you may select lower-risk bonds. A moderate-risk investor may select a diversified portfolio that includes a balance of stocks and bonds, while an aggressive investor may invest more in stocks or include riskier investments such as startups.

Regardless of the type of investment, financial advisory firm The Balance observed, you must weigh the potential reward against the risk — to gauge the relative risk of a particular investment and decide whether the pain is worth the potential gain.

When you put money into investments that involve higher risk than a savings or money market deposit account, realise that there is a possibility of losing some or all of your investment. 

On the other hand, investing in lower-risk assets that do not keep pace with inflation could mean that your investments rise in value slower than prices and you won’t earn enough to reach goals such as paying for your children’s education or a comfortable retirement.

One more consideration, especially for conservative millennials, is to consider your time horizon.

If you are in your 20s or 30s, you usually have decades to recover from a loss. While stocks or bonds may fluctuate in the short term, their long-term trend has historically been upwards, and you have time to wait for that recovery.    

A conservative millennial could then consider taking slightly more risk by investing in a diversified portfolio of stocks and bonds rather than just lower-risk lower-return bonds or time deposits.

Even though the value of the investments may periodically have a short-term dip, diversified portfolios of stocks and bonds perform better than just bonds over the long run.

By shifting a little way out of your comfort zone, you have the potential to get a better average return in the long run. Even if the value of the investment goes down in the short term, there’s time for the portfolio to recover and grow, and for you to save more later.

While your risk profile is not the only factor in selecting investments, knowing what risks you can accept can make you a better investor.