Get to know yourself
Everybody is different. To choose the right investment strategy, you need to be clear about your own needs and what you are trying to achieve.
Speaking to a financial adviser can help get you started because there are lots of things to think about.
Start by setting your goals. Then think about your investment timeframe – when do you want to spend the money? Then think about your attitude to risk. Knowing these things will help you identify what types of investment are suitable for you.
Set your goals and timeframes
Investing is about putting your money to work to achieve your personal goals. So start by identifying what you want to achieve by when. Choose goals that are realistic and ones that you can set a dollar value against. For example; if you were saving for a deposit on a house think about how much you can afford to put away. Setting goals forces you to plan, and having a clear goal -ideally written down – helps motivate you to stick to your plan.
Think about your goals first. Perhaps you are saving for a holiday, for a home deposit or to pay for a child’s education. Or your goal may be to boost retirement savings. You can see that different goals have different timeframes. You may only have 6 months or a year to save for a holiday but if you are saving for your retirement you might have 25 or 50 years.
Setting a timeframe for each goal helps you stay on track. You may have several goals, each with a different timeframe. Allocating a timeframe to each investment goal will enable you to think about how much you can afford to invest and how long it will realistically take you to reach your goal.
How much time have you got?
Setting a timeframe for each goal will help you work out how much investment risk you can afford to take.
If you are saving money over a short period of time it may be tempting to use higher-risk investments because they often come with higher returns. But growth investments, such as shares, are not appropriate for short investment timeframes as their value might drop suddenly, just when you need your money.
But if you are saving for a long-term goal, such as retirement in 25 years, then you have time to ride out the ups and downs in the market. This means you can take on a higher level of investment risk.
How do you feel about risking your money?
Risk tolerance also depends on your ability to cope with dips in the value of your investments. Factors that can influence your risk tolerance include your age, your financial and emotional ability to recover from capital losses and your health.
To decide where you fit on the risk tolerance scale, ask yourself this question: “How would I feel if I woke up tomorrow and found my investment balance had dropped from $10,000 to $7,000 within a month of investing it?”
If this drop would cause you to worry a lot and pull out of the investment, then a high risk investment is not for you. This is because you could pull out at the worst possible time and actually compound your losses.
If, on the other hand, a drop in the market causes you to start looking for bargain buys, then you are probably very comfortable with market fluctuations. You will be comfortable with a higher level of investment risk.
Your comfort level could be somewhere in between.
How much risk should you accept?
Your overall risk tolerance is the lesser of the risk you are comfortable with and the risk your timeframe will allow you to take. Your partner may not have the same risk tolerance as you. If you are considering a joint investment, you may need to compromise on an investment option you are both comfortable with.