Page 58 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Unit 3: Managing Investment Risks

Notes
Example: Suppose two people, one 30 and the other 60, had been similarly invested in
October 2007 in portfolios overloaded with stocks. By March 2009, both would almost certainly
have lost substantial amounts of money. But while the younger person has perhaps 35 years to
recover and accumulate investment assets, the older person may be forced to delay retirement.

Task Choose any five people of different age groups (between 25-60 years) and analyze
the difference in their investment risk appetite. Also find out the reasons behind their
investment choices.

On the other hand, having a long time to recover from losses doesn’t mean you can ignore the
importance of managing risk and choosing investments carefully and selling them when
appropriate. The younger you are, the more stock and stock funds—both mutual funds and
exchange traded funds—you might consider buying. But stock in a poorly run company, a
company with massive debt and noncompetitive products, or a company whose stock is wildly
overpriced, probably isn’t a good investment from a risk-management perspective, no matter
how old you are.
As you get closer to retirement, managing investment risk generally means moving at least
some of your assets out of more volatile stock and stock funds into income-producing equities
and bonds. Determine what percentage of your assets you want to transfer, and when. That way
you won’t have more exposure to a potential downturn than you’ve prepared for. The consensus,
though, is to include at least some investments with growth potential (and therefore greater risk
to principal) after you retire since you’ll need more money if you live longer than expected.
Without growth potential, you’re vulnerable to inflation.
Keep in mind that your attitude toward investment risk may—and probably should—change
over time. If you are the primary source of support for a number of people, you may be willing
to take less investment risk than you did when you were responsible for just yourself.
In contrast, the larger your investment base, the more willing you may be to take added risk
with a portion of your total portfolio. In a worst-case scenario, you could manage without the
money you lost. And if your calculated risk pays off, you may have even more financial security
than you had before.
Many people also find that the more clearly they understand how investments work, the more
comfortable they feel about taking risk.
Figure 3.1 can be effectively used as a general guideline for identifying how your investments
should be allocated. For example, if you fall in the red side, you’ll invest a higher slice of the pie
in equities. On the other hand, if you’re playing it safe, you’ll invest more in debt instruments.
As aforesaid, risk taking capacity is determined by investment horizon. Hence how long you
plan to stay invested for determines the right investment for you. This is mainly because equities
are fairly volatile, and you don’t want to chance your investment value dipping just when you
need it the most.
However, regardless of your investment horizon, make sure your portfolio has an equity
component to create wealth, and a debt component to protect your capital. Depending on your
risk profile it is only the proportion of equity: debt that would vary.

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