How Age affects your Investment Objective and Risk Tolerance
With the presence of various investment options, it is not enough that investors merely invest for the sake of “making a profit” or “gaining wealth”. Investors, first and foremost, must determine their specific investment objective before making any investment decision.
Knowing one’s investment objective helps set income expectations and guide an investor about possible investment options to avail of. While all these investment choices will attempt to earn a positive return for investors, the level of risk they take on to achieve income will differ greatly.
Before venturing into Setting your Investment Objective, let’s first understand your Risk Profile.
Know Your Risk Tolerance
Not all people can handle relatively high levels of risk. While some can take the fluctuations involved in trading in the stock market, others prefer to invest in low-risk, low-return investments like Time Depositss.
The choice of risk to take should primarily depend on the level of reward an investor expects from an investment asset. Of course, the higher the expected potential reward, the bigger the risk the investor must take. Risk could take the form of loss of capital, unguaranteed earnings, default of interest payment from the bond issuer or borrower, or anything that will not ensure the level of reward (income) expected from the investment.
Overall, the level of risk can depend on a variety of factors including one’s level of investment knowledge, marital status, culture, and beliefs, among others, but one’s age or phase in life could dramatically affect the level of risk the investor wishes to take.
Life Phases and Risk Tolerance
There are three (3) basic life phases that people typically go through, namely:
- 1. Accumulation Phase
The accumulation phase usually applies to an investor in his 20s or early 30s. His net worth is probably fairly small and he might not have a lot of money, but he does have one important commodity: time. In the future, he would want to settle down, buy a house, buy a car, have children, send them to college and then retire. He has a lot of plans for himself but he also has a lot of time to work to achieve these goals. In general, people in the accumulation phase will be most interested in growth and can make some relatively high-risk investments with the goal of making above-average returns.
- 2. Consolidation Phase
Once the investor reaches his mid-30s, he will likely move to the consolidation phase and stay here throughout the peak of his career until just before retirement. At this stage, his debts (including housing loan or car loan) should be nearly paid off, his children’s college expenses should be funded and his earnings should exceed his expenses. Retirement and estate planning are now his biggest concerns. People in the consolidation phase usually still have a decade or two to plan for these things, but since he knows he cannot continue working indefinitely and that he will soon rely on his savings, and not his salary anymore, his level of risk tolerance shifts from high to moderate.
- 3. Spending Phase
As the investor approaches retirement, he enters the spending phase. He has his daily living expenses covered, provided he is invested to receive a steady, stable income. He has no need to speculate aggressively and he knows the worst that can happen is to lose his entire savings. His biggest concern is inflation and how it eats into his own savings. It follows, then, that he is likely to become more risk-averse as he decide to place investments only in relatively low-risk assets that could beat inflation.
If the investor has earned a sizable savings and wealth, the spending phase might coincide with the gifting phase, during which the investor will provide for friends and relatives or other people. During this phase, his primary goal shifts from capital growth to estate planning and tax minimization, while working on personally fulfilling and rewarding activities such as charity work and philanthropy.
Going through all these phases is ideal and may not necessarily apply to everyone. The phases described above merely provide a guide and starting point for determining your own level of risk tolerance. Whatever your risk profile, it will typically be revealed to you when you start investing.
Now that you have identified your risk profile, it’s time to set your Investment Objective. Proceed to the succeeding article: What’s your Investment Objective: Capital Appreciation, Preservation, Current Income, Total Return?
Read these other awesome articles to be a smart investor:
- How to Invest in Stocks: A FREE Guide for Filipinos
- How to Invest in UITF in the Philippines (Guide for Filipino Investors)
- How to Invest in Mutual Funds: Complete Guide for Filipinos
- A Comprehensive Guide to PERA Investing in the Philippines
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