Investors’ appetite for risk has been tested to the limit in recent weeks during the Covid-19 pandemic. The right amount of risk to take in your portfolio depends on – your risk capacity as well as your risk tolerance, according to Morningstar research.
Risk tolerance relates to how you feel when the market is volatile. It tends to be less important than risk capacity. But if your risk tolerance is so low that there is a chance that you will throw out your plan when the going gets tough, risk tolerance is important, too.
In this research, Morningstar says young people who are saving for retirement are likely to have “have high risk capacities”, whereas “people who are about to retire have lower ones, though they still need to take some risk in order to ensure that their money will last.”
Retirees are in a tricky situation as they need to a cushion for retirement as well as enough cash for emergencies, for instance a sudden change of circumstance due to ill-health. Most people have three to six months’ worth of living expenses in cash, but some have up to a year’s worth of cash as an ‘ongoing cushion.’
Timing is key
Louise Woollard chartered financial planner (CFP) of Louise Woollard Financial – a Senior Partner Practice, St James’ Place Wealth Management, says: “It is only natural to be concerned about the short-term fluctuations in stock-markets. In fact, one of the only certainties is that it is impossible to know exactly how the markets will move.
As we have seen over the last few weeks, the sharpest falls and largest gains are often concentrated into brief periods of time. This can mean that if you try and time the markets to avoid the falls, you are highly likely to miss the gains. This is where the adage, ‘time in the market, not timing the market’ rings true.
Stepping back from the temporary volatility and emotion of investments to remember why you invested can be a very helpful tool. Short-lived unpredictability is a natural part of investing and the most important consideration should be, ‘when will I require my money?’.
History has shown us that the time people spend invested is crucial to delivering good investment returns – rather than trying to ‘time the market’. A well-diversified portfolio, which considers your objectives and when you will need your money, is crucial.
Being too cautious
Jon Doyle, founder and financial planner at Juniper Wealth management says: “We believe that time plays a far more significant factor in deciding risk tolerance than most traditional advisers.
“Rather than arbitrarily sticking to risk profiling outcomes we carefully plan with clients when this money is needed to input into advice around risk. A naturally cautious 25-year old should have significantly more equity exposure for their pension than say a naturally adventurous 50-year old funding an ISA aiming to provide deposits for children in five years’ time.
Doyle adds: “There is also a real danger at this moment that anyone taking too cautious an approach over the long term will find that after costs, fees and charges there isn’t enough return to bring return to the investor and make the risk worth taking. Therefore, focusing on asset allocation, costs and timeframes are essential to an investment strategy.”