Risk profiling: is there a difference in bull and bear markets?

Risk profiling is arguably the most important aspect of financial planning, after a needs analysis. An individual’s relationship to risk will inform exactly how and what they are able to invest in to meet their financial goals.

Financial planning, like surprise parties, is only fun if you like surprises – if not, the atmosphere will be anxious and awkward. It is often this surprise element that leads to disappointment and distrust. It is the same feeling you have when you’re expecting money back from the tax-man or you’ve been awarded a bonus at work. It is very welcome, but often not exactly what you were expecting.

To the average investor, the stock market and knowing where to invest your money is a minefield. We’re told to save and invest for retirement or that rainy day, but what are we actually going to get out of it at the end? Most investors don’t have a framework on which to hang their expectations when it comes to investing. If you have no idea what is reasonable then the stock market remains a potential get-rich-quick bonanza to you and the sky is very much the limit – but so, too, is the potential depth of your disappointment.

 

As always, the first place to start with investing is to understand the all-important characteristics that make up your investing personality and translate this into your particular risk profile. While this may seem pedestrian, I believe it is here that things tend to go horribly wrong.

Managing risk is about finding ways of not losing money. But it is also about making certain the purchasing power of your capital stays intact. While we all seek something that will give us the upside with no downside, I have yet to find this Holy Grail. So it’s important for you to interrogate your relationship with risk and loss.

 

By way of example, if I have R100k and the market drops by 20%, am I happy to live with R80k knowing that the market has to rise by 25% to breakeven again? This may take a year or longer and in the meantime inflation has run away with my purchasing power. Is this really okay?

In many instances, this is exactly what happens. If it doesn’t feel okay to you, run the numbers again until you feel more comfortable. Then you need to understand what drives returns in the market and what you can reasonably expect from each asset class.

It is a carefully constructed combination of these asset classes that will be delivering the returns on your portfolio. Returns are mostly a function of economic growth, the level of interest rates and inflation. Each asset class has a different risk and return profile.

 

Risk profiling is possibly the most important part of financial planning after a needs analysis. Your relationship to risk will inform exactly how and what you are able to invest in to meet your financial goals. Understanding risk is not only about trying to calculate the probability of losing money over certain periods of time, but arguably more important is ensuring that your capital growth keeps up with inflation.

Other than that, if your personal investment plan was well thought out at the outset, it should weather both bull and bear markets.