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Basics of Investing: Aligning Your Risk with Your Investment Goals

Posted On:17th,Jun 2023

Catagory:Personal Finance

On a good day, investing can be tricky, but with the information from this article, you will be ahead of the curve. Investing is a powerful tool for growing wealth, achieving financial goals, and securing a prosperous future. However, successful investing requires careful consideration of risk. The relationship between risk and investment goals is paramount, as aligning the two can significantly impact the outcomes of your investment goals. In this article, we will explore the importance of aligning your risk with your investment goals and how it can enhance your chances of success.

"The essence of investment management is the management of risks, not the management of returns." - Benjamin Graham

 

Understanding Risk and Investment Goals:

Risk, in the context of investing, refers to the possibility of losing some or all of your investment capital. Risk can also be viewed as the risk of not achieving your investment goals. These goals may include wealth accumulation, retirement planning, education funding, or any other financial goals.

Risk is an inherent component of any investment strategy, as the potential for higher returns often comes with increased risk. Finding the balance between risk and your investment goals is investing 101. 

 

Importance of Investment Goals and Risk Alignment:

Preservation of Capital: Aligning your risk with your investment goals helps ensure the preservation of your capital. You don't want to take too much risk and potentially lose capital, but you don't want to take too little risk and not achieve your investment goals.

Balancing Risk and Reward: Proper alignment of risk and investment goals allows for a balanced approach to investing. It is essential to strike a balance between conservative investments that provide stability and more aggressive investments that offer higher growth potential.

Time Horizon Considerations: Aligning risk with investment goals also requires considering your investment time horizon. Short-term goals, such as saving for a down payment on a house, typically necessitate more conservative investments to protect capital. In contrast, long-term goals, like funding retirement over several decades, allow for greater risk tolerance, enabling exposure to higher-yielding assets that may experience short-term volatility but offer growth potential over time.

Emotional Stability and Discipline: Aligning risk and investment goals helps maintain emotional stability and discipline during market fluctuations. When risk and goals are not aligned, investors may panic during periods of market volatility, leading to hasty decisions that can undermine their investment objectives. A well-aligned strategy provides a clear roadmap, allowing investors to stay focused on their goals and avoid knee-jerk reactions to short-term market turbulence.

 

Practical things for you to understand the investment risk: 

Now we know why it's important to link the investment risk with your investment goals. To make it more practical, you need to understand investment terms and how ASISA categories can help you align your risk levels with your investment goals.

Defining investment terms

As we mentioned, the more risk you take the longer your investment term should be. Hence by investing for a specific term you control your risk and give yourself a higher probability of achieving your investment goal. The below terms are an indication of when an investment will be required. For example, in an emergency, your emergency fund investment should be available within 3 days, or if you are saving up for a vehicle in 4 years, then medium-term investing would be relevant for you. 

Emergency:       0 to 3 days

Short-term:        0 to 2 years 

Medium-term:    2 to 5 years 

Long-term:         5+ years 

 

ASISA Categories and fund classification

ASISA fund classification applies to all collective investment schemes (CIS) in South Africa, which unit trusts are a part of. The classification aims to establish a standard for every fund and categorise them per their main asset class of investment. The naming convention works as follows. The first part is “Where”, this indicates the geographic exposure of the fund. The second part is followed by “what”, which indicates the main asset class the fund will be invested in. Knowing the classification of your fund tells the first part of the fund's story.

For a full analysis of all ASISA categories, please review this document.

Below are some of the most popular ASISA categories and we link their investment term to the category risk level in brackets. All unit trust funds' minimum disclosure documents or previously called fund fact sheets will inform you with which ASISA category the fund complies with. This will assist you in aligning your risk with your investment goal.

Before we get to the categories, here is a graph to illustrate the below categories over a 3 year period. Notice how the more riskier ASISA categories such as equities are used, the more the performance line moves up and down and the more conservative ASISA categories lines remain steady.

 

South African - Equity - General Funds (Long-term)

These portfolios invest in selected shares across all industry groups as well as across the range of large, mid, and smaller market capitalization shares. The portfolios in this category offer medium to long-term capital growth as their primary investment objective.

South African - Multi-Asset - High Equity Funds (Medium and long-term)

These portfolios invest in a spectrum of investments in the equity, bond, money, or property markets. These portfolios tend to have an increased probability of short-term volatility, aim to maximise long-term capital growth, and mostly comply with Regulation 28 (look for asterisks in the tool)

South African - Multi-Asset - Income Funds (Short-term)

These portfolios can have a maximum effective equity exposure (including international equity) of up to 10% and a maximum effective property exposure (including international property) of up to 25% of the market value of the portfolio. 

South African - Multi-Asset - Low Equity Funds (Medium-term)

These portfolios can have a maximum effective equity exposure (including international equity) of up to 40% and a maximum effective property exposure (including international property) of up to 25% of the market value of the portfolio.

South African - Interest Bearing - Money Market (Emergency / Parking money)

These portfolios seek to maximise interest income, preserve the portfolio’s capital and provide immediate liquidity.

Global - Equity - General Funds (Long-term)

These portfolios invest a minimum of 80% of the market value of the portfolios in equities and generally seek maximum capital appreciation as their primary goal. They do not subscribe to a particular theme or investment style and will be invested across all market sectors, as well as across the range of large, mid, and smaller market capitalisation shares

We built an investment selector tool to help you sort the best unit trust funds per ASISA category to ensure you invest in the best of the best per category to ensure you reach your investment goals. View the tool on Youtube

 

Summary

Aligning your risk with your investment goals is a crucial step towards successful investing. By understanding your risk, considering your investment time horizon, and balancing risk and reward, you can create a well-rounded investment strategy that maximises the potential for achieving your investment goals. Remember that periodic reviews and adjustments to your investment approach may be necessary as your goals and circumstances evolve.Happy risk-aligned investing!

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