Knowing your risk profile will help guide your investing

Given the way human brains are wired, it's a bit difficult to truly assess risk. We tend to over-emphasise the likelihood of things that scare us, or things that have happened recently; Sometimes we miss critical information altogether because we're focused on something else.

Understanding your risk profile is one of the most important steps for investing, and basically means your ability to withstand loss. It's informed by all of our human biases, plus your personal experiences, plus stories you've heard, plus your personal view of what success looks like. So your risk profile is as unique to you as your fingerprint.

So how do you work out how much risk you can handle?

Targets and timelines

It helps to know exactly what you're aiming for, and when. As an example, having more time means you have a greater capacity for your investment to rebound from possible market downturns, so you may be able to accept a little more volatility.

Investing in order to secure a new home deposit usually has a figure and a shorter timeline attached to it, as does a holiday fund. Saving for retirement is a priority for most Aussies but may fall into longer term goals. Perhaps you're investing out of curiosity, and learning the ropes is an outcome you're willing to pay for.

It's most likely that you have both short and long term goals, so first of all, write them down.

Find your tribe

Whilst there are many ways you can slice it, your appetite for risk usually leans towards one of three categories. It's good to know which one suits you right now, because investment options are also often described using these terms.

Aggressive (Think: Leonardo De Caprio in The Wolf of Wall Street)

This approach is generally taken by a confident, informed investor or someone who can handle a lot of volatility. With Aggressive investing, you're focused on maximising investment returns and you'll ride the rollercoaster for a shot at the prize. This type of investor may consider things like cryptocurrency, hedge funds and individual stocks.

Moderate (Think: Brad Pitt in Moneyball)

This investor relies on research, and may use it to build a diversified portfolio - one that includes a selection of higher risk and lower risk investments - or invest in a fund that takes this approach. They want gains, but won't bet the house. Moderate investing might include a 60/40 approach to a total investment portfolio - 60% stocks and 40% bonds - which, according to Morningstar investment research, achieved around 10% in annualised returns between 2010 and 2020.

Conservative (Think: Matt Damon in The Martian)

Investors in this category try to avoid risk altogether - potentially because the stakes are high and they can't afford to lose any money, or perhaps the safety of their investment capital matters most. This considered approach might include investments with lower returns like fixed deposit accounts, or higher security options like government bonds.

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In a nutshell: To identify your unique risk profile, figure why you're investing in the first place, and create a portfolio that makes you, and only you, feel comfortable. We always support a diversified approach, but you might have a single focus, or include elements of all three styles. Just make sure you allow for some flexibility for your profile to change over time - because unlike your fingerprint, your portfolio is always a work in progress.