What is your relationship with risk?

As an investor, risk tolerance is key to your financial freedom. While all investors want to avoid losing capital at all costs, being too conservative can result in the loss of long-term returns.

I regularly see clients, such as retirees, invest too conservatively in fear of volatility.

In the short run, their money is probably safe, but the returns that a money market fund offers may not keep up with inflation over time and won’t be enough to sustain them in retirement.

The converse also applies. If risk is underestimated, the volatility may be too much to bear for an investor, forcing them to withdraw before an investment has had time to give their required returns, or they may exit at the worst moment.

The way you think about risk relative to performance and the individual tolerance you have is important, as this influences your investment choices.

A successful investment is when there’s a match between the risk you expect and the fund’s actual risk.

Cultural, generational perceptions

A US study by Legg Mason about millennials’ views on investment found that 85% described themselves as conservative investors, with a lower portion of their investments in equities compared with that of their parents’ generation.

Millennials experienced the disruption of the global financial crisis up close, which left a riskaverse mindset in its wake.

Wealth and cultural differences also play a role in what you may view as risk.

Growing up in a home where money and investing are spoken about openly will make you more comfortable with taking on market risks than someone who has to learn about it later on their own.

Think about what ‘risk’ means to you:

1. Determine how risk could impact you. What are you trying to avoid: losing money, long-term poor performance followed by good performance, or performance that fluctuates? Often it’s less scary than the permanent loss of money that the term ‘risk’ evokes.

2. Work out your tolerance levels. Under what conditions would you become uncomfortable and how likely is that to happen?

3. Match the risk tolerance with the kind of investment you want to make. Generally, the higher the equity exposure, the higher the fund’s risk.

Get involved in how your money is managed so that you can take ownership of your financial future. Do your research: you can adjust your perception of risk so it matches the investment you choose.

Rob Formby is COO designate at Allan Gray