Investing is one of the most important decisions of our life. Despite the suspicion that it may cause us, there are many reasons in favor of it. Doing so is a way to prevent inflation from eating our savings, and more so in the current economic context. In addition, investments can help us diversify our source of income – not just relying on salary – and complement future public pensions. However, like any important decision, you have to know very well all the risks involved.
First of all, it is convenient that we know what our investor profile is, since it will measure our risk tolerance. The profile is adjusted to these four factors: financial objectives and time horizon (what do you want to achieve with the investment and by when), personal financial situation (how much savings and income do you have), investment knowledge and experience, and tolerance to possible falls. Therefore, this profile values objective and measurable factors, but also subjective ones.
In fact, one source of risk that plays a very important role in the success of any investment is oneself. It is useless to accurately analyze our investments if we get scared at the first chance and make hasty decisions. Therefore, as the experts at Fundación MAPFRE point out, of all the investment risks, the greatest is that the investor does not know himself or his tolerance for volatility, that is, for the rises and falls of investments that will always be there. On the other hand, although it has a bad press, risk is also synonymous with opportunity.
Beyond the personal profile of each one, a series of risks inherent to any investment must be taken into account: market risk, which affects the market as a whole, such as a strong economic crisis or a war; systemic risk, seen as that of that particular investment, whether it is a specific company by sector or the country in which it is located; liquidity risk, the one that determines how easy it is to recover money if needed; and the legislative risk, that is, that the laws change and this affects the companies in which you invest as well as investment products in general.
Protecting yourself from market risks is complicated and, as Fundación MAPFRE points out, the only way to do it is to use investment tools that do not work on it. For example, investing in the stock market and in the real estate sector, or in lending platforms for unlisted companies (crowdfunding). Thus, what affects the stock market may not influence the rent charged for a home or a loan to an SME. In the case of systemic risk, the way to avoid it is also to diversify investments with different sectors, companies and assets.
Then, regarding liquidity risk, we must know that there are products and markets that are more liquid than others. For example, with a pension plan we will have to wait 10 years to recover your investment, while with an investment fund it can be done at any time. Therefore, to avoid possible debt, it is always advisable to invest that amount of money saved that is not going to be needed in the present or in the immediate future.
To these risks are added others such as currency risk if you invest in companies or assets that are not listed in euros (an American company, for example), and two systemic risks such as the risk of inflation when it grows above your investments, or interest rate risk, which is beyond our control. In addition, not all risks affect all products or all investments equally, and how a product is taxed must also be taken into account before contracting it.
When investing, risk and return are closely related. Thus, the more risk assumed in an investment, the more potential return or profit it should imply. The general rule is that, the younger the investor, the more return and risk he can assume. Because a young saver who seeks to maximize profitability has a lifetime ahead of him to recover from a fall and invest for the long term. Instead, as the years go by, it seeks to consolidate what has been gained by reducing the risk of investments.
To find out what risk we should take at each moment of our lives, we can use the rule of 120. This formula consists of subtracting the age of the future investor from the number 120. The result is the percentage of the savings that must be allocated to a variable income, that is, the one with which a greater risk of loss can be assumed, but also the option of increasing potential profits. According to this rule, the rest of the assets should be allocated to a more stable and lower risk fixed income. For example, at 25 years, the result will be 95% variable income in the investment portfolio for 5% fixed income.
In this sense, age will also determine our goals. From 18 to 30 years old, the goal is to create a savings plan and growth investments for the long term, while from 30 to 50 years old, the goal is to increase income and savings, with both short- and long-term goals. (children's education, buying a flat, retirement...), and variable income will begin to be reduced, a trend that will be consolidated from 50 to 67 years of age and that will culminate, after 67, with much more conservative strategies and the withdrawal of investments.
However, it will be important to choose investments that are well understood and fit with the personality of each one and with our financial resilience, always marked by the needs and vital objectives. How to know if the best decision has been made when investing? Although there are no absolute certainties in this matter, there is a golden rule that is as simple as it is forceful: take the risk that allows you to sleep peacefully every night.