Risk tolerance: The foundation of your investor profile
Understanding investment risk will help you identify your investor profile and make financial decisions with peace of mind.
When the time comes to invest your savings, it's a good idea to have a strategy. One of the first things you should do is identify your investor profile to help you understand your feelings about investing. One of the pillars of your investor profile is your risk tolerance. Your age, financial situation, investment horizon, and other factors will help you gauge your level of comfort with investment risk. But first, you need to understand the meaning of risk.
What is investment risk?
Investment risk can be defined as the possibility of losing money on your investment or seeing little to no growth. Risk is closely linked to return: in general, the higher the probability of return on an investment, the greater the risk. The reverse is also true. Furthermore, greater risk means it may take longer to achieve a return.
Investments always involve some degree of risk, but there are ways it can be mitigated. For example, you can choose to invest your savings in a variety of asset classes, such as equities and fixed income. This way, fluctuations in one class counterbalance fluctuations in the others. You can also diversify within the same asset class, such as by purchasing the stocks of several companies, a strategy generally used with mutual funds.
How do you measure your risk tolerance?
Now that you know what risk is, the next step is figuring out how much you can tolerate. For example, if your goal is to grow your investment as much as possible, how willing are you to see a decline in your portfolio's value, keeping in mind that return goes hand in hand with risk? Several factors can help you answer this question:
- When will you need your savings?
- Do you have a project requiring short-term capital?
- Do you have an emergency fund to cover unanticipated expenses?
- Do you have a stable income or does it vary from year to year?
- How concerned are you about changing returns?
- How would you feel about a loss of value?
Answering these questions will go a long way toward determining your investor profile.
Identify your investor profile
It's important to be aware that any representative who offers you investment products is legally and ethically required under the Securities Act to evaluate your investor profile. This profile gives an idea of who you are as an investor, notably based on your personal and financial situation, your objectives, your risk tolerance, your short-, medium-, and long-term needs, and your financial knowledge.
The Autorité des marchés financiers (AMF) has an online questionnaire designed to help you determine your investor profile. The questions fall into three categories:
- Investment considered, which includes how you plan to save, your investment horizon, and your main objective
- Your financial capacity, to assess whether you can withstand temporary losses
- Your attitude to risk, or your ability to tolerate even a temporary decline in the value of your portfolio
The vast majority of financial institutions have their own questionnaire, based on the AMF's. Keep in mind, however, that this online tool is not a substitute for the expertise of an authorized representative. Your investor profile may also change depending on your personal situation and risk tolerance. For this reason, it is generally recommended that you reassess your profile once a year or whenever a new personal project arises.
If you enlist the services of a financial planner or mutual fund representative, your investor profile will be a valuable tool. It's not only a legal requirement, but also a way for these specialists learn about your investment goals and risk tolerance. The more they know, the better they'll be able to provide you with advice tailored to your current and future needs.
Mutual funds: Diversified investment vehicles
Mutual funds are a simple way to allocate and diversify your portfolio while respecting your investor profile. You can always find out the level of risk associated with a particular fund by consulting the Fund Facts or prospectus. The Fonds's FlexiFonds offering lets you choose from three types of mutual funds:
- The FlexiFonds Conservative Fund is more than 50 percent fixed-income securities, including Quebec government bonds, along with shares of the Fonds and other companies. This could be a suitable product if, for example, you're approaching retirement and looking for stability.
- The FlexiFonds Balanced Fund is 40 percent fixed-income securities along with shares of the Fonds and other companies. It allows you to limit fluctuations while focusing on growth. This may be a suitable product if you have a project requiring medium- or long-term capital.
- The FlexiFonds Growth Fund, predominantly made up of shares, is ideal for long-term investment growth. If you're saving for retirement in 20 years and comfortable with potential fluctuations in your return, this could be the fund for you.
In short, whether you've consulted a personal finance specialist or chosen to invest on your own (e.g., in a mutual fund), it's best to first identify your investor profile and reassess it on a regular basis. Since your situation and goals are likely to change over time, it's important to update your investment strategy to match.