Aggressive, cautious, or somewhere in between? Understanding your investment personality can help you make better-informed investment decisions that will benefit you in the long run. Here's how to find out what your financial personality is.
The American bank BBVA Compass suggests there are four basic questions that will help you identify your investment personality:
- Can you tolerate a high risk of losing money?
- Do you expect to make extremely high returns?
- Are you comfortable with investing over a long period of time (more than 10 years)?
- Will you need access to some or all of your money at short notice?
If you answered "yes" to all the questions, you are likely to be an aggressive investor. This means you believe that over time, the stock market will go up. You’re willing to take the risks of ups and downs in the stock market, because you believe that's where the most money can be made.
Aggressive investors, who are comfortable with risk, tend to favour equities. Within equities, less cautious investors tend to make snap decisions. They may, for example, think nothing about putting 5% of their portfolio in a new listing or in a small- or mid-cap fund that they've heard good things about.
Discovery financial adviser Louw Venter says that risk-loving clients can be more difficult to work with. “Risk-takers worry me the most – often they feel good when they make money, but when they lose money it becomes more difficult. These personalities like jumping into the deep end.”
However, he points out that there is a big difference between risk-takers who "have made volatility their friend and are prepared for the consequences" and "greedy investors who try to make a quick buck, but do not have the necessary knowledge".
On the other end of the continuum are those who answered "no" to all the questions. These are ultra-conservative investors who typically steer towards cash and bonds, and are more concerned about the potential loss of capital than they are about potential returns. They simply don’t tolerate risk.
Risk-averse individuals typically calculate and extrapolate just about every possible eventuality before making an investment. They're the kind of person who reads all the fine print, including (often complicated) costs and performance fee schedules. Their equity exposure is typically through balanced funds.
From a financial adviser's perspective, these clients can be more easily managed. "My role as a financial adviser is to make them comfortable with volatility over time – but you can do it slowly, until they feel comfortable with more risk," says Venter.
Between the two extremes are those who answered "yes" to some questions and "no" to others, and these people are likely to balance their investments between the various asset classes, including equities and cash.
Finding a balance
Canadian investment resource Investing for Me suggests that the first of those four simple questions (Can you tolerate a high risk of losing money?) is key to understanding what kind of investor you are: "For the most part, an analysis of your investing personality focuses on how you respond to losing money. Do you accept the loss and move forward? Or does the lost money bother you for days and months later?"
A knowledgeable financial adviser interprets your responses to these kinds of questions. Understanding your responses will help you identify in finding an investment strategy that strikes a balance between offering you comfort and attempting to remove unhelpful emotions from your investment and savings decisions.
This will allow you to compensate for your biases by increasing the equity portion of your portfolio if you're too cautious, or making sure you have exposure to other asset classes if you are too much of a risk-taker. Your portfolio will be the better for it.
Between the two extremes
You may have answered "yes" to some questions and "no" to others.
More "no" than "yes" answers indicate that you're likely a moderately conservative investor. As a person who isn't comfortable with big risks, you'll rather be happy with lower returns for the safety of less risk. A financial adviser might suggest a mix of stocks and bonds, but mainly bonds.
People with equal "no" and "yes" answers are balanced investors who don't want too much risk, but do want the advantage of higher returns through some risk. If you're a moderate, balanced investor, an equal distribution of stocks and bonds might be advised for you.
More "yes" than "no" answers point to an investor who is probably moderately aggressive. As a moderately aggressive investor, you view stock market risks as worth the long-term rewards if you stick it out when markets are down and wait for them to go up again. Financial advice for you will entail putting most of your money in stocks and the rest in bonds.
Financial literacy brought to you by Discovery Invest
Whether you're a risk-taker or someone who shies away from risk, educating yourself on how to invest your money is a good place to start.
Investing, like much in life, is a skill. Mastering it, however, is not as simple as sticking to theory. This Youth Month, find out how your financial personality influences your financial decision-making.
You've set goals and you're well on your way to being someone who saves towards reaching their financial security goals. Then suddenly, the whole family has the winter sniffles and there are healthcare costs your medical scheme doesn't cover.
Investing doesn't have to be a challenge. By following simple principles and avoiding common mistakes, you can enjoy the benefits of successful long-term investing. Discovery Invest looks at the most common but avoidable investment mistakes.!