For those who are new to investing, it is quite unlikely that you will know right now what type of investor you might be. So we will go through some questions designed to help you to better answer that.
How much time can you give to investing?
Firstly, it can be useful to ask yourself how much time a day or week can you give to your investing journey? For some, the answer to that may be plenty of time, whereas for others it might be very limited due to work commitments for example. The more time someone has, the more potential they have to be an active investor. On the flip side, for someone who cant dedicate much time to investing, then their focus is more likely to be long term and they are more likely to hold positions for a longer duration. This strategy isnt a bad thing though as we do want to have patience when it comes to investing, but for the person who is dedicating a few hours a day, they may be able to take advantage of the shorter-term changes in market conditions.
Now we know what you might be thinking, isnt someone who is in and out of positions/investing considered a trader? And to an extent, yes. One of the main differences between trading and investing is the timeline for holding positions. Investing often takes a longer-term approach whilst trading focuses on shorter-term strategies. So if someone had more time, they could be both a long-term investor and a shorter-term investor/trader. They might be invested in certain markets for a few years but take advantage of a change in a companys share price following a good earnings report for example.
What are your investing goals?
The next question to ask yourself is, what are your short/medium- and long-term goals? What are you looking to achieve? Are you looking to make a full-time transition to being a full-time investor? Or are you looking to build wealth over time? Again, for someone who is looking to do this full time, they may hold investments for slightly shorter positions on average as they have the time to take advantage of volatility, whereas someone looking to save for retirement is going to have a longer-term approach. It is important to set goals and understand what exactly you are looking to do.
How frequently do you want to invest?
It is also worth asking yourself, how active do you want to be? Do you want to do this all the time? Or is this something you want to do alongside your work? For someone who trades or invests more frequently, in theory, there is more opportunity to generate returns, which of course is a positive. However, this does work both ways lets remember. For someone who gets into more trades/investments there is a risk they lose more. Short-term investing requires more skill than long-term as we have mentioned. Generally, markets over the long term do go up but trying to time the market perfectly is very tricky.
What level of risk are you comfortable with?
Another question to ask is, what level of risk am I happy to take? You have probably heard the saying the greater the risk, the greater the reward and to an extent, this could be true.
If we take the generalised example of a young individual with hardly any bills to pay, and no huge financial commitments versus an older individual who is nearing retirement, it is more than likely that the younger individual will be more comfortable taking more risks than someone ready for retirement as someone older is less likely to invest in something that in theory could drop 10-20%. The older individual is more likely to prefer a steady investment that maybe doesnt have massive rewards but it importantly doesnt have big risk either. In contrast, the youngster has time on their side and investing in something slightly more risky could be very fruitful and even if it doesnt work out, in theory, they still have time on their side to recover any financial losses.
When we look at risk appetite, we can go into more detail and actually focus on the different weightings of assets within someones portfolio. Before we do that lets discuss what assets we can consider to be more and less risky.
Some assets that might be considered risky could be commodities like oil and gold, stocks, crypto, high-yield bonds and emerging market currencies, whereas safer assets could be government bonds from countries like the United States and dividend-paying stocks from long-established companies. Remember, no investment is risk-free but there is a huge spectrum when it comes to many risks is involved.
On the spectrum, we can say high risk is investments that may yield high returns but also may yield large losses. Moderate risk are investments that generally offer a stable return and capital appreciation in the long term, and low risk are investments are those that have the lowest risk but generate the lowest level of returns.
Various portfolio examples
Now lets have a look at some examples of different portfolios based on different risk appetites. Remember when looking at these examples that past performance is no guarantee of future results but Fidelity and Morningstar have gathered some interesting data for us to discuss.
For a Conservative portfolio, which has a weighting of 50% in Bonds, 50% stocks the average annual return was 5.93%. For a more balanced portfolio which was 60% stocks, 40% bonds, the annual return went higher to nearly 8%. For a more aggressive portfolio where it was 85% stocks and 15% bonds the return on average went to 9.77%. So as we can see, on average on the data they pulled from 1926-2021, the more aggressive portfolio averaged higher returns but lets look at the worst 12-month return of each portfolio. For the most conservative it was -17%, for the balanced one it was -40% and for the most aggressive it was -60%. So here is a great example of why someone who is more risk averse will be happier to have less reward to reduce risk. On the flip side, when we focus on the best 12-month return for each portfolio, the results are wide-ranging. For the conservative one its best was 31%, for the balanced one it was 76% and for the aggressive portfolio it was 136%. For someone who is younger or just in general, happier to take risk, the risk-reward will make sense for them to be more aggressive in their portfolio and investment decisions.
Hopefully, by answering the questions we have gone through in this lesson you will have a better understanding of what type of investor you are going to be and what level of risk you are happy taking. You can of course change your style of investing throughout your investing journey and as we have discussed, those earlier on may be happier to take more of a risk to potentially generate bigger returns, whereas those closer to retirement are just focussing on maintaining their investment account with as little as risk as possible.
The next lesson will focus on What should your investment goals be?
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This communication is for information and education purposes only and should not be taken as investment advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments. This material has been prepared without taking into account any particular recipients investment objectives or financial situation, and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or a packaged investment product are not, and should not be taken as, a reliable indicator of future results. TBanque makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication.
