How Much Investment Risk Should You Take?
One of the first things we ask a new client to do is complete a risk profile questionnaire.
It is useful, but I would never look at the result and think, great, you are a growth investor, job done.
Because the real question is not simply how much risk you are comfortable with.
It is how much risk makes sense for what you are actually trying to achieve.
If you take too much, you can expose yourself to losses you are not prepared for. If you take too little, your money may not grow enough to get you where you want to go.
That is why I think about investment risk as a balancing act between your goals, your timeframe and how you are likely to behave when markets fall.
In this episode of Financial Autonomy, I unpack how risk profiles work and some of the things that can change the answer.
How much investment risk should I take?
The right amount of investment risk is the amount that gives you a reasonable chance of reaching your goal without exposing you to more volatility than you can realistically live with.
I usually want to know three things.
What are you investing for?
When are you likely to need the money?
What are you going to do if markets fall sharply?
Those questions can lead to very different answers.
You might be someone who is completely comfortable investing aggressively. But if the money is for a house deposit in two years, that does not suddenly make shares an appropriate place for it.
There is simply not much time to recover if markets fall.
On the flip side, you might be naturally cautious but have superannuation that could stay invested for another 30 or 40 years. In that situation, you may decide you are comfortable accepting more short-term ups and downs because the money has such a long timeframe.
Same person, different pot of money, different answer.
What is a risk profile?
A risk profile is basically an assessment of how comfortable you are with uncertainty in your investment returns.
Different financial planners use slightly different labels, but you will often see categories such as defensive, conservative, balanced, growth and high growth.
At the lower-risk end, you would generally expect to see more cash and term deposits.
At the higher-risk end, you are more likely to see a larger allocation to growth assets such as shares and property.
In our practice, for example, a balanced portfolio might have around 60% in growth assets and 40% in defensive assets. A growth portfolio might be closer to 80% growth assets.
That gives us a useful starting point.
But I would not get too hung up on the label.
Being a growth investor does not mean every dollar you own should be invested for growth. The purpose of the money still matters.
How do I work out my risk tolerance?
Most financial planners start with a questionnaire.
You might be asked something like: if your investment fell by 10%, how long would you be willing to wait for it to recover?
It is a useful question.
But it is also very easy to be brave when you are sitting at a desk filling in a form and nothing is actually happening to your money.
It feels quite different when markets are falling, your account balance is down and every headline seems to be telling you things are about to get worse.
That is where your real tolerance for risk tends to show up.
I also find people often become more comfortable with investment risk over time.
They might begin fairly cautiously because they are new to investing. Then they live through a few market ups and downs and realise they can tolerate more volatility than they first thought.
Experience can change the answer.
Couples can make this interesting too.
It is very common for one person to be the finance person. They read the books, listen to podcasts and feel comfortable with the market moving around.
The other person wants absolutely nothing to do with any of it.
Unsurprisingly, they often end up with very different risk tolerances.
In those situations, I would rather start with the goal than start arguing about the portfolio.
What are you both actually trying to achieve? When do you want to retire? How much are you willing to save? How much do you want to spend now?
Once you agree on the destination, the investment conversation usually gets much easier.
Can you take too little investment risk?
Yes.
This is one of the parts of investing that I think gets overlooked.
Most people hear risk and think about losing money.
But there is also the risk of your money not growing enough.
Imagine someone who is investing for retirement but hates seeing their balance move around. Keeping most of their money in cash and very defensive investments may feel comfortable.
The problem is that, over a long period, they may end up making it much harder to build the amount they need.
That is still a risk.
I am not suggesting everyone should simply take more risk. The point is that feeling safe today and having enough money in the future are not always the same thing.
That is why I like to start with the goal and work backwards from there.
What is the difference between conservative, balanced and growth investments?
The main difference is usually how much of the portfolio is invested in growth assets compared with defensive assets.
Growth assets include things such as shares and property. They can move around more, but they are generally held because of their potential to produce stronger returns over long periods.
Defensive assets include cash, term deposits and bonds. They are generally used to provide more stability.
A conservative portfolio will usually have more defensive assets.
A balanced portfolio sits somewhere in the middle.
A growth portfolio usually has a much larger allocation to growth assets.
But just because you have a growth risk profile overall, it doesn’t mean your whole portfolio has to be invested that way. Part of it may have to be conservative because you know you will need the money soon.
Or you might consider yourself conservative but invest your super more aggressively because you have decades before you need to touch it.
That is why this label is only part of the story.
Should I take less investment risk as I get older?
Maybe, but I would not make the decision based on age alone.
Timeframe is usually more useful.
Someone in their 40s investing for retirement may still have decades ahead of them.
Someone who is one or two years away from retirement is in a very different position.
As retirement gets closer, I often see people become more conscious of market falls because the money feels more immediate.
They know they may soon need to start drawing on it.
Wanting more stability at that point can make a lot of sense.
But I would not say retirement automatically means everything should suddenly become conservative.
Retirement itself can last decades, so some of that money may still have a long investment timeframe.
How do you know if your portfolio is actually right for you?
That is the harder question.
You can know what you own, know whether your fund calls you balanced or growth, and still have no idea whether your investments are actually doing the right job for you.
I would want to know what you are trying to achieve, when you need the money, how much risk you can genuinely live with and whether the portfolio gives you a realistic chance of getting there.
That is where financial advice becomes useful. We can look at the whole picture, rather than one investment or one risk-profile score, and work out whether your strategy still makes sense for the life you are trying to build.
If you are wondering whether you are taking too much risk, too little, or whether your portfolio is simply not lined up with your goals, book an appointment with us and we can work through it with you.
This article is for educational purposes only and does not take into account your individual circumstances. If you would like tailored advice, we can help you work through the numbers properly.
