Risk is embedded in every part of our daily lives. How we handle risk is essential, especially in financial and retirement planning. Correct risk management can lead to a financially secure retirement.
A portfolio consists typically of various assets, such as a mix of equities, bonds, cash, commodities, or even property. The allocation of these assets is equally important, as this determines the risk of the investment. Each asset has a different risk and reward level and reacts differently to markets over time.
Equities, as they are invested in companies, have the potential for higher returns but also carry a higher risk of volatility and losses. Bonds are more stable and have a lower risk and return. For example, when the economy is doing well, investors may increase their exposure to equities to earn higher returns, but when volatility is present, and the economy is not doing well, investors may decrease their exposure to equities and increase their exposure to more stable assets like government bonds and commodities like gold.
Each investor has a risk tolerance level that they are comfortable with. Some might prefer taking higher risks in hopes of achieving higher returns. The purpose of any portfolio is to preserve and grow capital. This means earning enough interest to beat inflation and grow capital. Generally, an investor nearing retirement would lower their risk level to protect capital for retirement, e.g. decreasing exposure to equities and stocks and increasing bonds and cash.
It is important to note that an overly cautious approach to risk may result in a portfolio losing value as returns are lower than inflation, or an overly aggressive risk approach may be detrimental if markets are highly volatile.
It is essential that you consult with a financial advisor before investing to determine the risk level that you are comfortable with.
Investors are comfortable with different risk levels. Some prefer taking a higher risk stance in hopes of achieving higher returns, while others prefer a more conservative approach to investing. Risk can be classified into five different categories, although depending on the fund or financial institution, there can be as many as seven levels.
Financial risk is often determined by the investor’s age or the length of the investment period. The longer the period, the riskier the portfolio can be, as it has time to even out the market’s ups and downs.
Defensive investors tend to target capital preservation. Their investments will typically be deposit-based, but with some exposure to risk assets, in order to provide the potential for maintaining capital at, or above, inflation.
Cautious investors tend to target a modest level of growth via a portfolio of mixed assets. Their portfolios will primarily be invested in fixed-interest assets but also defensive equity and property to achieve relatively stable long-term returns. In the short term, they typically expect some volatility.
Balanced investors tend to target longer-term capital growth. Their investments will be mainly in fixed interest, equities, and some ‘alternative’ asset classes. They typically expect some volatility in return for the possibility of higher long-term returns.
Moderate Growth investors tend to target a return using a portfolio with a higher equity content and a wider geographical spread. Their investments will be predominantly in equities, with an exposure to fixed interest and property, to provide growth-oriented diversification. They typically accept some volatility in return for the possibility of higher long-term returns.
Growth investors tend to target long-term capital growth by adopting a higher risk level. Their investments will typically be equities but also some ‘alternative’ asset classes to achieve long-term capital appreciation.
New professionals and graduates in the employment world have the most potential to build substantial retirement savings. A 25-year-old graduate has roughly 40 years to build a retirement nest egg. With the power of compounding interest, they are in the best position to build wealth before the added financial responsibilities of marriage and children.
Also, employers often match employee contributions in workplace pensions, so it makes sense to opt for the maximum contribution allowed. Young investors have time on their hands and usually choose a high equity allocation to their portfolios, like 80% in equities/stocks and 20% in bonds.
It is vital to find a financial advisor who will help you plan your retirement and guide you through your professional career, retirement, and beyond.
The 30s are the most crucial time for a professional to commit to retirement savings. There are still 30 good years to build a nest egg. To achieve a similar result with retirement as someone in their twenties, this age group would have to save around 10-15% of their income. Although financial responsibilities may have increased with a mortgage or starting a family, it is imperative to contribute as much as possible towards a private pension and workplace pension.
Professionals in their forties need to seriously shift their focus towards retirement. With a shrinking time frame to save enough for a comfortable retirement lifestyle, a serious commitment is required to ensure retirement security. This could entail reducing debt to have more available for retirement savings. For those starting on retirement savings, a more aggressive or growth-orientated portfolio could help grow their retirement savings pot, but only an advisor can help choose stable companies with good track records for your portfolio.
For those already 20 years into savings, there could be a possible shift from growth and moderate growth to a more balanced portfolio with less risk to preserve capital but still earn good returns. Depending on the professional’s individual retirement needs, there could be a shift in the asset allocation to 70/30 equity to bonds or even 60/40.
The key here is not only to build capital but also to preserve the retirement pot. Nothing is worse than losing a large portion of your retirement investments because the portfolio was high risk. High risk means possible high returns, but it could also mean high losses. And with only ten or fewer years left to save, depending on retirement age, there is not enough time to smooth out any volatility or recoup any losses in the portfolio.
Most retirement savers at this age move their portfolios into balanced portfolios with a higher bond allocation, such as a 50% bond to 50% equity ratio. Now is the time to sit with your financial advisor and plan the kind of retirement lifestyle you want in line with your savings.
Post-retirement risk is very real. A financial advisor’s role is not complete when you retire; it is actually more important than ever before. They are responsible for preserving your hard-earned savings so you need not worry about money in your golden years while ensuring that your investment returns beat inflation. As you get older, your medical and health needs increase. You may spend less money on travel and hobbies, but your medical care increases. This must be added to your retirement plan.
For example, a 25-year-old invests £250 a month into retirement savings over 40 years, earning an average interest of 8% p.a. with a 2% annual increase for inflation. That amounts to over £1 million at retirement of 65. That is over £900,000 compounding interest accrued over 40 years.
A 35-year-old would have to invest over £500 a month for 30 years to achieve the same result. That’s more than double the premium, with only £600,000 earned in compound interest.
A 45-year-old would have to invest a whopping £1,500 a month to achieve a similar result with only £500,000 in compound interest or invest a lump sum of £100,000 with premiums of £1,000 monthly.
Risk is an important aspect of retirement investing, and the right asset allocation could mean the difference between a financially secure retirement and one filled with belt-tightening.
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