Considerations When Determining Investment Risk Tolerance

When determining tolerance for risk, the most important question to ask is: when will the investment returns will be needed? If the time horizon is relatively short, risk tolerance should be more conservative. For a long-term investment outlook, there is room for more aggressive investing, because investors have more time to recoup any possible losses and are therefore theoretically more tolerant of higher risks.

Net worth and available risk capital should be important considerations when determining risk tolerance. Net worth is simply your assets minus your liabilities. Risk capital is money available to invest or trade that will not affect your lifestyle if lost. Therefore, an investor or trader with a high net worth can assume more risk. The smaller the percentage of your overall net worth the investment or trade makes up, the more aggressive the risk tolerance can be.

Regrettably, those with little to no net worth or with limited risk capital are often drawn to riskier investments  – like futures, options, or collectibles – because of the lure of quick, easy and large profits. This approach is dangerous because when too much risk is assumed with too little capital, an investor can be forced out of a position too early, resulting in a loss. By investing only money that you can afford to lose, or afford to have tied up for some period of time, you will not be pressured to sell off any investments because of panic or liquidity issues.

When it comes to determining an investor’s risk tolerance, the answer will vary based upon the age, investing experience, net worth, and risk capital of the investor, as well as by the actual investment being considered. Younger investors can take more risk because of the long-term strategies they are employing. Conversely, an older individual has a shorter investment horizon, and would have a much lower tolerance for risk.

It is important for investors to understand the idea of risk and how it applies to their investing portfolio. Making informed investment decisions entails not only researching investment reviews, but also having a deep understanding of one’s finances and risk profile.

War Has An Impact On How Investors Invest Their Money

A war can have a significant impact on how investment markets perform, and subsequently how investors will invest their money during times of military conflict. Wars create economic and political turmoil that affects the performance of key industries, such as manufacturing, retail, and financial sectors. Moreover, inflation becomes a constant threat to investors’ savings and returns.

To combat the adversity in domestic and global markets, investors need to adjust their investment portfolio holdings to include assets that offer lower exposure to risk and preserve their wealth. The ideal strategy is to avoid volatility while maintaining an appropriate rate of return. Popular investment choices during times of conflict include certain stocks and hard assets.

Stock Market

Although there are definitely risks associated with stocks, there are some stock market investments which perform well in times of war. Foremost these include oil companies and certain manufacturing sectors. Many of these select industries maintain profitability because they directly contribute to the war effort.

Oil

Given that a large amount of the world’s oil supply originates in the Middle East, conflicts in this region raise concerns about access. This, according to the basic laws of supply and demand, begins to drive the price of oil upward. High oil prices eventually stimulates more investment in oil exploration and drilling, encouraging technological innovation under the pressures of a renewed belief that high prices mean oil is permanently running out.

Defense, Bio-Tech, And Construction

When it comes to choosing stocks during times of war, the defense, biotech, and construction sectors are leading the war effort. Companies like Lockheed Martin (LMT), Northrop Grumman (NOC), and Raytheon (RTN) are making sizable contributions to the U.S. war machine, and are the most profitable during times of conflict. With wars engulfing many areas of the world with increasing violence, there is no question that investors should consider investing a larger share of their stock profile to the defense sector.

Hard Assets

There are a few hard asset investments that have historically proven that they can continue to perform well, even during times of conflict and war. Perhaps more importantly they can preserve wealth. Since the global financial crisis in 2008-2009, three alternative investments have emerged as profitable opportunities; these are investing in shipping containers, gold, and fine wine.

Shipping Containers

Approximately 90 percent of the world’s trade is moved in cargo containers by the global container shipping industry. This constant international demand has proven to deliver steady returns to shipping container investors, even during times of war and political upheaval. Their intermodel shipping applications and widespread adoption make them indispensable to companies and countries.

Gold

Although certainly not as popular an investment as it once was, gold has historically been a store of wealth. For centuries, investing in gold has been the go-to investment strategy in turbulent times. With that being said, gold appears to have lost its glitter since the global financial crisis in 2008-2009, and has had difficulty gaining traction since then.

Collectibles

For some investors, collectibles – like investing in fine wine – provide a tangible asset that can be converted back to cash relatively easily. The liquidity and return of these investments depend greatly upon demand and thus do carry an elevated level of risk to investors. Nevertheless, tangibility of this class of assets has steadily risen in popularity.

In Closing

During times of war and conflict, investing becomes very challenging. Political uncertainty leads to economic uncertainty, and vise versa. Making low-risk investments in this environment is difficult, and takes education and experience to navigate the rough financial waters.

Perfect Investment Portfolio Has Equities And Fixed Income

Today, based on numerous long-term measurements, many or most stock markets appear to be heavily overvalued. Bonds also look expensive by their own long-term standards. Investors need an investment portfolio that is exposed to all likely environments, and committed to none. One which is based on intelligence and reasonable suppositions about the future, and not merely data mining from the past. There is only so much the past can tell you.

In addition to knowing how an investment works, you need to understand what specific role it plays in your portfolio and how it improves your portfolio’s performance. Although there is no predetermined number of investments you should own, once you get beyond five or six, chances are you have got a lot of overlap or you are venturing into more risky investments you don’t need. The fact of the matter is that you don’t need to constantly be adding new asset classes or investments, just because investment firms introduce them or you read favorable reviews. In fact, if you do, you’re more likely to end up with an unwieldy hodgepodge of investments that are difficult to manage, rather than a simpler portfolio that more efficiently balances risk and return.

To get the maximum return while taking the minimum amount of risk, it helps to think of your portfolio as being split into two parts: an equity portion comprised of stocks, and fixed income portion made up of bonds, GICs, and income-generating investments. Generally speaking, the higher the percentage in equities, the greater the risk. That said, there should be a minimum 25% holding of equity-regardless of age. Taking this cautious approach to stocks is less risky than a portfolio invested 100% in fixed-income investments. Moreover, it protects against the negative effects of inflation.

Traditional-minded investors with a love for investing in gold are likely to be shocked by the absence of their favorite precious metal in “the perfect portfolio.” But, fewer investors are prepared to commit any money to an investment that generates no income. Unlike a bond, the metal pays no interest. There is no dividend and it may not protect you against the worst forms of inflation. Moreover, there is no implicit guarantee that it will appreciate in value.

All accomplished chefs know the secret to cooking a great dish is mixing the right ingredients, in the right amounts. Surprisingly, putting together a well-constructed portfolio isn’t much different. As in cooking, you must begin with the correct basic ingredients, in this case stocks, bonds, and alternatives, but if you get the proportions right, the result will be a huge success.