When most people hear the word "risk" in an investment context, they instinctively think of something to avoid. However, at DecisionMakers, we view risk as one of the most crucial elements in developing a comprehensive financial plan. Understanding and properly managing risk isn't about avoiding it entirely—it's about harnessing it strategically to help you achieve your financial goals.
What Risk Really Means
In financial planning, risk represents the degree of uncertainty around achieving a specific outcome. While investment professionals often measure this through volatility metrics like standard deviation or Sharpe ratios, the practical meaning is simpler: it's the probability of not meeting your expected financial outcomes.
Think of it like planning a road trip. You might expect to arrive at your destination in six hours, but traffic, weather, or mechanical issues could extend that journey. Similarly, your investment journey may experience delays or detours, but proper planning helps you navigate these challenges and still reach your financial destination.
The Three Pillars of Risk Assessment
Risk Tolerance: Your Comfort Zone
Risk tolerance measures how much investment volatility you can psychologically handle without abandoning your financial plan. At DecisionMakers, we use the sophisticated Finametrica psychometric questionnaire—a 25-question assessment used by millions of investors worldwide—to accurately gauge this crucial factor. Risk Tolerance Assessment
Consider two investors: Sarah, who checks her portfolio daily and loses sleep over market fluctuations, and Mike, who views temporary losses as buying opportunities. Even if both have identical financial situations, their different risk tolerances require different investment approaches. Sarah might be better suited to a conservative 30/70 portfolio (30% growth assets, 70% stable assets), while Mike could handle a balanced 50/50 allocation or even higher growth exposure.
Risk Requirement: What You Need to Succeed
Risk requirement examines how much investment risk you must accept to achieve your financial goals. This is where mathematics meets reality. If you need a 10% annual return over 40 years to accumulate sufficient retirement funds, a conservative portfolio generating only 4% won't meet your requirements, regardless of how comfortable it feels.
When we identify a mismatch between tolerance and requirement, we help clients explore their options: developing greater risk tolerance through education and gradual exposure, adjusting their goals to more realistic levels, or finding alternative strategies like increasing savings rates or extending working years.
Risk Capacity: Your Practical Limitations
Risk capacity considers your timeline and cash flow needs. Even if you have high risk tolerance and requirements, your circumstances may limit your ability to take on volatility. For instance, if you're purchasing a home in two years, those funds need stability regardless of your general risk appetite. Similarly, retirees making regular portfolio withdrawals may need more conservative allocations to ensure consistent cash flow, even if they're comfortable with market fluctuations philosophically.
Practical Risk Management
Effective risk management extends beyond investments. We consider various life risks that could derail your financial plan. Employment income risk from injury or illness can be managed through income protection or trauma insurance. Market timing risk can be addressed through dollar-cost averaging and diversification.
Often, we'll recommend multiple investment strategies aligned with different goals and timeframes. You might have an aggressive growth portfolio for long-term retirement accumulation alongside a conservative portfolio earmarked for your children's university fees in five years.
The Risk-Return Relationship
Higher returns historically come with higher risk—this fundamental principle drives our investment recommendations. By not utilising your available "risk budget," you may be inadvertently extending the time needed to achieve your goals or settling for outcomes below your potential.
Our role is helping you live the best life possible with your available resources. Sometimes this means investing more aggressively during younger years to retire several years earlier, with the peace of mind that comes from understanding and accepting the associated risks.
Every New Zealander's situation is unique, and we strongly recommend seeking advice from a qualified financial adviser.
At DecisionMakers, our advisers are available to discuss your financial questions in a 45-minute complimentary consultation, available in person at our Takapuna or Tauranga offices, or via video or phone call.
These conversations consistently help people clarify their financial direction and make more informed decisions about their financial future.
This is also a chance to determine if you will benefit from engaging with a DecisionMakers adviser.
