Should I be careful not to suffer any loss to my capital

3 December 2016
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Category Singles
3 December 2016, Comments 0

For anyone, whether you are single or not, the question of protecting your capital is an important one. Nobody wants to see their capital wiped out at whatever stage of life they are at. But an important thing to consider is the risk and return of your investments and the time horizon you are measuring against

Risk vs Return

It is well documented that the higher the risk the higher the potential return. But that also means the larger the potential loss so what does that mean to an individual with a pool of capital. Should they be careful about suffering loss or accept that there are risks and take them

should-i-be-careful-not-to-suffer-any-loss-to-my-capital

Time Horizon

Lets imagine two people. Mr Joko is a young man in his thirties and has a pool of capital. He has many years until retirement age and his risk appetite can be higher than Ms Dewi who is in her late 50’s and is nearer retirement age. If Ms Dewi already has built up her pool of capital to see her through retirement why would she want to take unnecessary risk and suffer any siginificant loss to her capital

You can see from here that the time horizon has a real impact on the decision making process and is also linked to the investment that you choose as an individual.

Risk Profile

There are different types of risk profile. You are either a

  1. risk taker in which you actively seek risk in the hope of a higher return
  2. risk averse in which you avoid risk and want to play it safe
  3. risk neutral in which you are jus medium risk taker or just like to sit on the fence

Risk Assessment

An important part of the process to identify whether an individual is either a risk taker, risk averse or risk neutral, is called a risk assessment. The individual needs to give this serious thought so that the types of products that they consider for meeting their investment needs is well matched to their investment goals.

If you are in Ms Dewi’s position you will have spent a lifetime of working and investing to build up a pool of capital. The question she may have is what she wants to do with the capital. If it is for her to retire on then it would be sensible to play it safe from now until she retires. In other words her risk profile should be one of risk aversion.

What that means is that the type of products that Ms Dewi looks for is safe. If she can pay 100 for a product and it pays 3 but her principal is protected ie shes not going to lose the 100, then that probably suitable for her even though the 3 is not a large return

Type of products that may be considered

Fixed income products with good credit rating may make a suitable class of investment for Ms Dewi. The principle here is that she is looking for something safe. Like putting money in the bank that pays interest like her savings account. The amount of interest may not be very large so the return is small but she is not going to lose her life savings.

A fixed income product can be a government bond that pays a fixed coupon amount of the notional principal. While Dewi may not be able to buy such products directly, there are investment companies that have funds that you can purchase and the underlying assets are fixed income products. It may be possible to buy units of the fund that invests in the safe assets but she should be careful about what they fund is allowed to invest in. If it is one that is suitable for low risk taker then no problem

Diversification

Diversification is another consideration for any person wishing to allocate their investment portfolio. The principle of diversification is that you do not put all your eggs in one basket but spread your risk across a few asset classes or products. This will help protect you because it is less likely for all assets to be down at the same time. Some will be up where others may be down and the gains and losses within the portfolio may cancel out to a certain extent. Why does one asset go up when another goes down is dependent on how well correlated they are. If they are negatively correlated it means that the prices tend to move in opposite directions. Positive correlation would mean moving in the same direction

Summary

Whatever the risk profile of the individual, it is important to exercise care in the choice of investment product. It is advisable to seek the guidance of your professional financial advisor so that they may be able to guide you in our choice.

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