Understanding your attitude to risk and reward is a crucial step when you’re working out an investment plan.
- If you’re too bold, you risk getting spooked out of your investments at the first inevitable setback.
- If you’re too risk averse, your investments might not grow enough to meet your goals.
Unfortunately it’s very hard to figure out exactly how risk tolerant you are in advance.
The following tool from Which? Money might help, but you should only use it for interest, not as your sole source of insight into how to build your portfolio.
In the top row, you select how much money you think you’re prepared to lose in a year by clicking on the different percentages, from 5% to 40%. The tool takes this as an indication of your risk tolerance. It then suggests a portfolio, and tells you how a £10,000 investment could perform over various time periods if things go according to plan – and if they don’t!
You should experiment to see the range of possible outcomes delivered by the tool. The lowest long-term return from the safest portfolio beat the equivalent low returns from the riskiest choice when no growth occurred, for example.
But the latter had an expected return nearly 5x higher when things did go according to expectations.
Once you’ve got a sense of how you’d like to spread your assets, check out our article on passive ETF portfolios for some practical ideas on implementation.
A note on the portfolios suggested by the tool
Which? tells me the asset allocations and assumptions were devised in collaboration with financial services firm Barrie & Hibbert, who it partnered with on the stochastic risk modelling. The brief was to create portfolios that illustrated downside risk for different risk appetites.
It says the models were back- and future-tested through thousands of scenarios, based on a combination of past performance and future assumptions on risk measures such as inflation, interest rates, gilt yields and equity premiums.
The portfolios are monitored and updated on a quarterly basis, though Which? says it created them as “set and forget” allocations. By this, it means they are not tactically or dynamically managed, but should probably be rebalanced every six to 12 months.