Risk: Know Yourself
Posted by Gail | Filed under Investing
Perhaps the most important of the Golden Rules of investing is this one: Know what kind of investor you are. Your investment risk profile measures your risk tolerance — or how much fluctuation in the value of your investments you can deal with – and your risk capacity — how much risk you can afford to take based on your unique situation.
It’s so easy to become engrossed, attracted, enthralled by the stories you hear of wonderful performance, sure things, and better than average returns. But as you focus on putting your portfolio together, and as you adjust it over time, you’ve got to be true to yourself and your investment personality.
Some people are total chickens; they want their money to be completely safe, and cannot tolerate for an instant the idea of losing a penny. Others have more of a damn-the-torpedoes attitude; they want big returns and they are prepared to take big risks to get them. But there’s a real risk in going into small caps if you’ve only deluded yourself into thinking that you can stand the kind of volatility that is inherent in smaller companies.
Inevitably there will be times when markets correct so you must be completely comfortable with the investments you’ve chosen in order to hold tight to your portfolio plan and stick out the down-turns. Giving in to the fear will hurt more than hanging on to watch as the markets start moving upwards again, as they eventually will.
Lots of companies have the basic “Investment Risk Profile” test like the one here. This is a good place to start, but not a good place to stop. These questions are the beginning point. You must be prepared to delve deeper so you’re sure of your risk profile. When you’re challenged by a slip-sliding market or a change in personal circumstances, that’s not the time to suddenly discover you’re not quite as aggressive as you thought.
You have to have confidence in the risk profiling exercise you go through, or you won’t stay the course. You’ll do exactly the wrong thing at the wrong time: You’ll panic and you’ll bail. If you’re comfortable with your risk profiling, you won’t even need to look at the markets. You’ll have made choices that are right for you, and you’ll stick with them. To go the extra step so that you are completely comfortable, head on over to investored.ca. I designed this risk-profiling questionnaire to make people think a little harder and, perhaps, know themselves a little better.
Everything has some risk attached, even doing nothing. Leaving your money under your mattress means it will eventually wilt under the pressure of inflation. At current rates of inflation, your $20,000 has to grow to $36,000 to have the same buying power in 40 years. So doing nothing means you could end up poorer by virtue of the fact that your money just won’t go as far. If you don’t believe me, go ask your grandmother what she paid for a loaf of bread.
Tomorrow I’ll talk about Risk & Your Investment Time Horizon
Gail Moment: I’m doing Breakfast TV in Toronto this morning. I woke up to find myself with not a lick of make-up… I don’t usually wear make-up, and the BT thing happened quickly, and … hey… I forgot. I’m a pretty girl, but even I know better than to try to do TV without eye-liner. What to do? Well, I hit the closest 24-hour drugstore and “sampled” a new concealer, eyeliner, face powder. And I bought a lipstick… seemed only fair! I liked the eyeliner so much, I may go back. Desperate times call for desperate measures!
February 11, 2009 at 8:00 am
Gail, that makeup thing is what I used to do in a pinch when I ran out of eyeliner before an interview. (Not often, but has happened before!)
I went to Sephora in Toronto, got my face made up by a professional (er.. a subtle palette that is) and waltzed into my interview right after, poised and calm….
Now I just keep an extra pencil of eyeliner just in case because my eyes don’t exist without eyeliner.
February 11, 2009 at 9:50 am
Gail. you seem like such a together lady that it’s funny to imagine you running around trying to get a free make-over at a Shoppers Drug-Mart. I love it when you share tidbits about your life – it’s one of the reasons we love you – because it reminds us that you are not only incredibly smart, practical, generous and funny – you are also human.
Regarding investing, one point I want to make about knowing what kind of investor you are. As a young person, (27) I am keen to get my life together. Keen to get the right job and get a stash of money and be financially stable. Hearing about people making money through investments, property, etc, it’s easy to want to jump in with both feet.
However – I would encourage all other young people like myself to remember that even if short-term investments do not yield as much return, you don’t want to rush into something that is going to penalize you. Locking too much of your cash into long-term investments will cause you to a) take a penalty out when you remove the money prematurely, or b) force you to use credit cards when you realize the cash you needed was locked into investments.
The reason I say this is because when you are young, there are a lot of things you’re saving up for. At least I am, and I don’t think I’m alone in this boat. There are homes to buy, weddings to have, children to have. The lifestyle upgrade that I discussed with Erran (moving from the “student” life to an “adult life.”) There might be changes in your near future that require money – planning to travel before you settle down? Move to a different city for a better job?
It might just be me, but I see a lot of changes for me in the next 5 years or so, and all of them are going to cost MONEY. So as much as I want to see a good return on my savings, I know I also need to keep it relatively liquid in short term investments or accessible savings.
Just something to think about, when you consider what type of investments are for you. I don’t know if this is helpful to anyone else, but they are thoughts I have had, and maybe they will click with someone else too.
February 11, 2009 at 10:29 am
Agreed with SaverQueen (hi SQ *waves* ha ha). Regardless of risk aversion, not all funds should be locked down in “long-term investments” – i.e. equity-based mutual funds, stocks – for the same reason as SQ mentioned. If you are young (I’d say 40 and under), then retirement savings can be more long-term based and can sustain risk. Of course, for those looking at retirement, you probably should be out of risky assets about 5 years prior to retirement (give or take depending on how the market outlook is).
But for more short-term financial plans – weddings, home downpayments, etc. – , definitely watch out for equity-based assets, because when the time comes to grab it, it could be ugly (like now!). For me, my retirement savings are slotted for all equity-based mutual funds, but miscellaneous savings are in mainly in non-equity funds – i.e. a bond fund. While more risky than a money market fund or GIC, I am quite comfortable with the risk (1 year return has been about 5% vs. money markets return of 2.8%). Perhaps foolishly, I look at it as no risk really. For those with minimal knowledge on bonds, think of them as loans to governments or corporations and they pay you interest on borrowing your money. Naturally, corportations are riskier loaners than governments, so their interest payments will be higher, and some corps will be more riskier than others – think Shell Gas vs. Nortel. So the risk for a bond fund would be a company/government not paying it’s loan, but typically the real downside risk comes from interest rate fluctuations. Example: if you’re holding a bond paying 8% interest and rates drop, then that fund becomes more valueable, so if you were to sell it before it expires (or “matures”) then you would make a profit. Consequently, the reverse can happen in that you can lose money if the bond is less valuable. But generally, the risk is lower than equity based funds, so better suited for medium-term timelines.
Generally, if I have some extra money kicking around, I’ll put it into my bond fund rather than placing into my equity-based RRSP mutual fund because I already have a systemtic contribution plan, and wouldn’t want to try to “time” the markets with the extra money.
Anyways, to see the points SQ was talking about regarding our chats, go to the following Gail posting:
http://gailvazoxlade.com/blog/archives/378
February 11, 2009 at 10:35 am
…FB you seem wise beyond your years, and are so lucky for it! I wish I had had that kind of insight a few years ago. I’m only a few years older than you but a few years can do all sorts of things! As Gail might say “Good on ya!”
I am getting there, though, as my story says – inch by inch!
February 11, 2009 at 10:35 am
ah, that was meant to be SQ…I’ll have my brain back some day…
February 11, 2009 at 12:05 pm
Thanks so much michelle! You are so kind. I certainly haven’t gotten it all figured out yet… some days I feel pretty confused, haha! But I really appreciate your support and the support from all the other readers/bloggers here!
February 11, 2009 at 1:58 pm
I am such a chicken when it comes to investing! I want guarantees, even if they are small gains… My husband nearly throws up with nerves when our account is below average even for a month, so he is risk-timid too. So how the heck did we end up getting whacked by this “market correction”? We were told the only way we could even remotely get to our old age with any savings was to have SOME money in diversified stocks… good thing there is lots of time to recover for us. (Also a good thing that I love my work and will likely do graphic design until nobody will hire me anymore, and then I can switch to fine art in my golden years! My hubby is a talented mechanic and will always be tinkering on things for people. He calls it his paid hobby.)
February 11, 2009 at 2:06 pm
I agree with Saver Queen that it is good to have a savings account where you can easily access cash for those big purchases. However, I strongly believe in have some money set aside in a discount brokerage for long term investment and the younger you start the better – the power of compounding and dividends (which still get paid even when the market is down)!
I had mutual funds that I bought long term when I was in university. Now that I’m working and just hit the 30 mark, I sold the mutual funds and bought blue-chip, high quality dividend paying stocks. I’m not throwing down an insane amount of money here (cause I’m far from rich) so that I have none in my savings account, but I put down enough to buy 50 shares of 4 stocks. It’s not much, but it’s a start and whenever I have extra (after putting into my short-term savings) I buy more shares. So that hopefully in a year or two I’ll have 100 shares in about 5 blue-chip stocks. Eventually I want to add to that.
You aren’t locked in – so if a dire emergency came up (that can’t be taken care of with my emergency fund) or I want to use the money to buy a house in a couple years I can sell some stock. If you prefer low-risk mutual funds, make sure you choose ones that are no load and have low MERs – that way you don’t pay a fee for cashing out early.
February 11, 2009 at 3:08 pm
I find it interesting that the focus of so many now is on ‘guaranteed’ returns, but few consider the effects of inflation on their guarantee. A 3% guaranteed return with inflation at 2% is very quickly consumed. That said, I agree wholeheartedly with SQ above though on choosing investments that can grow with you — I see many people around 28 buying houses etc solo when renting is offers much more flexiblity. Now I bought my loft when I was 26 but I’m a long-term kind of guy (lived there 5 years, went from single to dating to living together to married all in the same place) but not everyone is. Like Shakespeare said, above all else know thine self I guess.
February 11, 2009 at 3:43 pm
Hi there Gail,
I read your comment just before 8 this morning and was watching BT, but I was too late, but my mother did see you. She said she would have woke me but didn’t want to disturb my sleep. A shame I didn’t get to see you on BT, but I’m sure you enjoyed meeting the lovely Dina. She’s fantastic. At the very least, I got to see the Chris Noth on BT! Did you see him Gail?
Respectfully,
Josef
February 11, 2009 at 4:39 pm
Timelines for investing are also a good thing to consider. For my RRSPs – since I have to work another 9 yrs, I’ve put them in slightly higher risk investments, padded with some tried and true funds (like RBC); for our RESPs – since one kid already is using it, and the other one will next yr, we’ve folded everything into GICs to protect our investments during these trying economic times.
BTW – Gail, you’d look lovely with or without make-up. Your smile is the best.
February 11, 2009 at 8:00 pm
SQ – I’m in the same boat as you (same age too). This year has been a year of changes for me for sure.
In the last year I was downsized, moved across the country, bought a lot of “stuff” for my new town (like sporting equipment to take advantage of what my new home has to offer), purchased a car (or, realistically, aquired a car and a loan!), and am looking into purchasing a house.
Now, even though I live in an expensive town I also have gone from being single to living with a “significant other” to share expenses with, and a roommate. Just over a year ago I had my own apt in a nice are, paid all the utilites alone, did not own a car (no parking costs, used public transport, and paid to carpool to work).
Fyi, I was on EI for only a few weeks but I still had to wait almost 5 months to actually see any $ – and my account didn’t have any complications or anything. You can bet the government is even more busy with EI applications now than they were last January. Having living expenses in an emergency account is a MUST in my opinion.
Part of me wishes I had contributed more regularly to my RRSP’s when I first started working, but I did contribute some and I kept a big buffer in my savings account.
The good side to RRSPs is they can be used towards a down payment, going back to school (if you go full time), or a first time car purchase… so there is some flexibility there.
I am lucky enough to have come out of university debt-free, and have never carried credit card debt… I was able to book a flight to Japan on a whim (3 months before the trip, though) about a year after I started working.
I agree – it is important to have a BIG buffer in your savings/emergency fund. It allows me to be spontaneous (we just found cheap tickets to Hawaii) without being irresponsible. Was a trip to Japan worth it? That could be a nice addition to my down payment on a townhouse… and the furniture I bought for my old place and sold for a % of what it’s worth to move here? You bet it was! But I was never looking for how to buy groceries…
(Whew! apparently my 2 cents take up a lot of space!)
With regards to Gail’s article, my banker asked me the same questions… how much risk are you willing to take? And what are your goals? Without knowing that he couldn’t offer me much.
February 11, 2009 at 10:54 pm
Gail, I missed your appearance on Toronto’s Breakfast Television this morning. (I’m sure you looked fabulous!) My husband is searching all over BT’s website to find a recording of it. Does anyone know where to find Gail’s interview on BT on the internet? I didn’t see it on this website, just Gail’s interview on BT from last year. Any help will be muchly appreciated!
February 11, 2009 at 11:19 pm
I don’t know why my posting never got published…too bad.
I did add on to what you said SaverQueen, and it was a bit lengthy, and it’s late and I have no desire to hash it out again. Le sigh.
February 12, 2009 at 4:26 am
I’m almost 40 and just switched my GIC style RRSP to Mutual funds. I chose to wait until I felt comfortable investing. I didn’t bet it all, but completed the questionnaire and Mutual Funds were the way to go for me. I checked out the rate of return and it was an average of 6%. It may not be sky high but its where I felt safe. When I chose to retire I’ll have 30 years of pension behind me, plus 25 years of investing. I’ll be in good shape financially.
February 13, 2009 at 6:19 pm
According to the Investment Risk Profile test I definitely fall into Gail’s poultry category. Not only am I a total chicken but the moment the markets even twitch I am the headless one running down the street screaming “the sky is falling, the sky is falling. A particularly nifty trick without lips (do chickens have lips?) although my true love says that I have always been talented at talking out of my butt.
This behavior became particularly bad last October when the sky actually was falling. I got so nervous that the Hubster had to stick a strip of duct tape along the bottom of the TV screen to blot out the CTV NewsNet stock market ticker. All those little red arrows pointing down. So sad.
I find it odd that I am now so terrified about losing ANY of the value in our money. When we were up to our necks in debt with no savings it was not only “Damn the torpedoes, full speed ahead!” but “Damn those torpedoes are sweet. Since they’re on sale I’ll have one in every style and caliber”.
I honestly didn’t care what our money could, should and would have been earning for us and didn’t want to know anything at all about interest rates.
Now that we actually have some money invested and earning I have become obsessed. (And lest you think we are real players I should just mention that we have $1347 in a mutual fund.)
I think I am so paranoid because we lived the live now, pay later lifestyle and it was only after we crashed and burned that we found out that we were going to pay in ways we never imagined. We wasted way too much time and playing catch up now is going to be almost impossible.
We are concentrating on paying down the mortgage and the car and investing in low-to-no risk investments. I hope that we will eventually get braver as we become more knowledgeable and actually save up enough to take a risk.
The investments we have are barely keeping up with inflation and I know this is silly but for now at least I am sleeping at night with the capital safely tucked under the mattress of the CDIC.
My parents had no credit debt and owned every thing they had when they retired and with their savings, Dad’s small pension and CPP and Old Age they lived a comfortable retirement for over 20 years. I THINK we will be in the same situation but then who knows. On TV the other night I heard a financial guy say that the CPP and Old Age Pension funds were the biggest Ponzi schemes going. Gail, please say it isn’t so?