December 2001 Volume 82 Number 12 "serving the protectors"
Shares
By Ruth McCance, ASX Investor Education

Risk – the secret to a successful investment portfolio

Every investment carries some kind of risk. Even choosing not to invest in anything can be risky. Regardless of whether you are starting small or have been investing for years, a secret of successful investment is choosing investments which suit you, so you can still sleep at night, even when the market falters.

Generally, the higher the potential return from an investment, the higher the risk, or potential for loss, associated with it. Time is also an important factor: a short timeframe increases the risk from fluctuations in value, which a longer timeframe can tend to smooth out.

The first step is to learn about the risk and reward associated with different investment types. Traditionally, fixed interest is viewed as the lowest risk with the lowest return, then property and then shares.

We are all at risk from inflation, which will erode the value of our wealth over time. It can be hard to beat inflation by leaving money in a savings account, or even by using interest-paying products, once we have paid tax.

Also, the value of bonds may decline in times of increasing interest rates. Investing overseas introduces currency risk, that returns could be reduced if the Australian dollar rises over foreign currencies.

Even within one type of investment, such as shares, the level of risk varies. This depends often on the track record of the company and the likelihood of it delivering consistent, increasing levels of profit. For example, biotechnology companies still developing their products may deliver excellent returns if they are successful. Alternatively, their products may fail at one of the development stages.

The risk/reward balance applies to both individual investments and whole portfolios. Someone who has all his or her money in one blue chip stock or in one quality investment property is still exposed to risk from non-diversification: if that one investment fails, all his or her money is at risk. This means that diversification is an important tool to reduce risk. If you are starting small, you may decide to use managed funds to give diversification.

The second step is to identify what professional advisors refer to as your “risk profile”. This requires skill to do well and advisors use a number of tools and experience to accurately measure the specific needs and profile of each client. This then helps to identify the appropriate investment strategy to suit individual needs.

Risk profiles incorporate a number of factors, including:
Stage of life – the issues you face and your investment timeframe will vary throughout your life. This also means that a periodic review is useful to make sure your situation has not changed.
Amount to invest – this will affect your ability to protect your investments through diversification.
Investor category – some people are greater risk-takers than others. It is very important that you develop a clear understanding of your attitude toward money and risk. It helps to develop a realistic idea of what you expect to earn from your investments.

Your advisor will probably identify you with one of five common investor types. These range from the conservative investor – who may keep around 25% in cash and only put 25% in shares – to the aggressive investor prepared to take greater risks in pursuit of potentially higher gains and who may have 70% in shares and only 5% in cash.

Whether you are a large or small investor, the same principles apply.

Understanding risk and defining your risk profile may be a lengthy exercise and does require understanding of each investment but, with the combination of professional advice, forms the base for starting a successful investment portfolio.

This was prepared with the assistance of the ASX Investor Education unit. It is not intended as investment advice or as a recommendation of specific securities. For more information call 1300 300 279 or visit www.asx.com.au

This article contains general information only. It is not intended as and must not be relied upon as investment advice. You should consult a licensed professional advisor prior to making any investment decision.

The information contained in this article is provided in good faith and derived from sources believed to be accurate as at the date of publication. However, no warranty of accuracy or reliability as to such information is given. Australian Stock Exchange Limited and its associated and related companies will not be liable for any loss or damage arising in any way from or in connection with anything provided in or omitted from this article or from any action taken or inaction in reliance on the article. This article does not contain an invitation or offer to invest in securities or other financial products and nothing in this article is to be taken as ASX endorsing promoting or expressing any opinion on any securities or other financial products.

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