When consulting with a client who wishes to invest, it often happens that our mandate is to achieve the maximum return on their funds, but with the minimum risk to their capital.
This may sound like a simple instruction, but first the client has to understand what it is that they are saying.
The field of investment options are vast and how do we narrow these down to recommend a suitable investment option for a client?
Each client comes with a specific set of circumstances relating to age, employment, funds available, time horizon for the investment and many more.
So, for example, a 65-year-old who is retiring from his pension fund will be a very different investor to one of 45 who has some funds available that he wishes to invest in the stock market.
These two examples indicate some of the crucial aspects that have to be considered. The term the investor wishes to invest for, for example, has to be determined and when does he require the capital to be returned, if at all?
The person who is retiring may be more interested in the income generating capability of his capital (which is one of the many functions of investment returns) while he understands that his capital may not necessarily be returned. I know that there are variations on this theme, when one considers living annuities, but that I will discuss in further articles.
An investor investing “extra” funds in shares would also want the best return on his capital, but may understand that there is a greater possibility of fluctuation in the value of his capital. It is however important to mention that not necessarily all investments in share portfolios should be classified as risky.
It is important that the investor has at least a basic understanding of the various investment asset classes, the possible risk attached to each and how they interact with each other.
For instance, cash is seen by many investors as a low risk, stable investment asset class. However, the risk attached to cash, is that inflation will deplete the real buying power of your money.
The other main asset classes, shares or equities, bonds and property each have their inherent risks and benefits. Therefore, many investors are suited to a mixed portfolio containing differing combinations of the various asset types.
As a rule of thumb, investors have to remember that high returns are often accompanied by high levels of risk. This is why determining an investor’s risk profile may be a handy exercise to see whether they do in fact have such a big appetite for risk.
Risk profiling is however not an exact science. It is merely an indication of the investor’s views on the various aspects of investment at that particular time.
One often finds that anyone who has been disappointed by returns quickly becomes a far more conservative investor!
Next time, more about different investment vehicles and the benefits provided by each.