In uncertain markets, how much investment risk can you really stomach?
In volatile times there are opportunities to dive in and buy bargain stocks, but this always comes with risk. Before buying investors need to know exactly how much risk they can stomach.
Buying in market dips last year, and snapping up some good companies at cut prices was a strategy that paid off. The market slump after Brexit provided an opportunity to do just this, with many investors cashing in.
However, the enemy to profiting in these environments is when markets fall, investors lose their nerve and sell. By doing so they potentially sell at the bottom of the market, or at least before substantial gains have been made.
This selling crystallises losses, and it can take longer to build up returns and get back to the original position.
Before embarking on bargain buying investors need to know whether they have the stomach to ride the rollercoaster of markets. Asking theoretical questions can help to determine your true risk tolerance.
Questions such as: “Imagine you were in a job where you could choose whether to be paid salary, commission or a mix of both. Which would you pick?”
Or: "By how much could the total value of all your investments go down before you would begin to feel uncomfortable?"
Establishing that "risk tolerance" is vital because it means you can structure your investments in a way that reduces the chance of returns that are too volatile for you to handle.
Those who are more risk averse can structure a portfolio that is likely to be steadier during big market events, such as Brexit, while those who can tolerate more volatility can venture into riskier assets.
The problem is that we are often a poor judge of our own risk tolerance. Many investors focus on the gains available by investing in riskier assets, but when confronted with losses and investments falling in value they are less comfortable.
FinaMetrica, a technology company, asks investors questions about their personality and likely behaviour to establish investors’ true attitude to risk.