Why you need to know your risk profile
As an increasing number of first-time investors enter the stock market, we are finding that they are investing in areas that are not only unsuitable for them but also their portfolio.
Investors typically flock to investments that produce the best return from last year, last month and even last week when investing in stocks, cryptocurrencies or the latest IPO.
Over the decades, I have found that when presented with a choice of having a blue-chip portfolio or growth portfolio, over 90 per cent of investors choose growth because they believe they will make more money from this style of portfolio.
While it is logical to expect higher growth from this portfolio style, what most don’t consider is the volatility that a growth asset or portfolio is subjected to over time.
Growth investments have much larger swings in price than defensive assets and, as such, investors need to be able to handle this risk. Unfortunately, however, inexperienced investors tend to buy growth assets that have already risen through fear of missing out or they sell out too early for fear of losing.
Based on this behaviour, there are two lessons that can be learnt:
- the first is that you can’t buy yesterday’s returns because buying into something that has already risen strongly believing you will gain the same return in the future is a flawed strategy;
- secondly investors need to invest in assets that are congruent with their risk profile.
Let me say that risk is a far more important consideration than the return you will achieve when assessing an investment, which is why this should be every investor’s number one priority.
Right now, there are masses of inexperienced investors attempting to profit from Bitcoin believing it will achieve last year’s return in the next year. Of course, when it is rising, everyone is blissfully unaware of the risks. But once again, this thinking is flawed, as Bitcoin is a very volatile investment and when it does fall, it falls heavily.
Unfortunately, when Bitcoin does start to fall again, many will see how risky this investment really is, particularly the inexperienced. No doubt, those who have put their money in Bitcoin or other cryptocurrencies will come to regret their decision.