Risk is the potential for loss where there is also potential for returns.
Perceptions of risk change from person to person, and where some investors prefer an entrée, others will go for a three course meal.
Your risk profile plays a crucial part in your investment strategy; it’s like checking your car before you take a road trip.
Whilst checking your car you may notice that a tyre seems low or worn – do you pump it full of air, replace it, or leave it be? If you’re driving from Melbourne to Adelaide and didn’t replace the tyre you’d be taking a high-level risk, but it’d be a low-level risk if you’re driving to the local shops and back.
Just as you would kick the tyres, check the oil and fill up on fuel before you drive off into the sunset, it’s necessary to look closely at your personal situation before you invest to know what risks you may face, and how willing you are to take them.
To determine your risk profile, a property investment professional will take into account your investing experience, tolerance for and attitude towards risk, investment goals and objectives, timeframes, age and income.
In a nutshell: the level of risk you take should depend on your appetite for risk, the end goal, and how much time you’ve got to achieve it.
Let’s take Emma’s risk profile for example:
Average property value range: $350,000 - $450,000
Gross rental return: 5% i.e. property valued @ $350,000 rents for $350/week
Age that Emma would like to reach her goals by: 65
Timeframe: 15 years
Passive income target: $100,000
Verdict: Based on the above assumptions, Emma would require approximately six debt free properties producing $2,100 in combined weekly rent. The emphasis here is on the words ‘debt free’; not only does Emma need an acquisition strategy, she also will require a debt reduction strategy to ensure that no debt is being serviced with her passive income in retirement. Seeing as Emma is only just entering the property market at age 50, I would say that she may be inclined to take higher levels of risk to make up for lost time – when really – Emma should be more conservative with her investments to protect what could have been accumulated. In hindsight, these high-risk decisions could have been mitigated if she started investing at an earlier age.
Restricted time limits together with property investment create an extremely high-risk situation.
Other high-risk situations include people with substantial cash-flow; some take the money for granted, possess a gambler mentality and make riskier decisions based on the premise they’ll be able to recover faster than someone with low cash-flow.
I often meet clients like this who took their high cash-flow lifestyle for granted, overlooking the opportunity to build a wealth creation strategy while times were good. Often, high income earners live a life of status and reward themselves too soon. When the time comes to scale back, if they loose their high income or they want to retire, that’s when the panic starts as they realise that they’ve done nothing to ensure that the standard of living they’ve grown accustomed to can be maintained at a time when they really should be able to enjoy themselves.
So, how do you minimise risk?
One way to eliminate a high level of risk with all of your investments is by starting sooner and using ‘less sexy, more boring (i.e. tried and proven) techniques to lay your foundations. This isn’t always possible – as you can see with Emma’s situation – but the more time you have, the better-informed decision you can make.
As Warren Buffett says, ‘risk comes from not knowing what you’re doing’. Mitigating risk comes down to education about the investment situation. So in reality, once you know every possible ‘risk’, it is no longer a risk, simply a potential outcome.
How much is too much when we’re talking about risk?
Simple: don’t risk what you can’t afford to lose.
When your property investing starts to put your own home or your family’s financial security at risk, I think we’d all agree that’s when enough is enough.
Ask yourself these questions:
- Are you risking more than you need to?
- Do you know the opportunity costs?
- Could you achieve the same result by going down a different path?
What’s your appetite for risk?
Your risk profile will help you see areas where you need to reduce risk, and areas where taking a larger degree of risk is acceptable. Remember, you are the driver so the level of risk you feel comfortable taking is entirely up to you.
Property is an excellent vehicle to leverage your way into financial freedom, but it’s only effective if you create a strategy and risk profile that’s been catered to your own individual circumstances, goals and appetite for risk.
Get in touch on 1800 600 890 and let’s talk about your risk profile.