Know yourself to decide on your investment
In the first part of this series of articles discussing how to set your investment goals as an investor, you learned how the mechanics of ROI make property investment so attractive. In that article, you will have read how property is different from other investment assets because of the control you retain to shape the amount of income and capital growth you achieve.
In this article, I’ll take you to the next step in your decision-making process. By the end of this article, you’ll have a greater understanding of what type of return is best for you and how to determine your own risk profile.
What do you want to achieve in life?
This is the first question you should ask before making any investment. You will need to think about your lifestyle goals, and when you want to achieve them. Of course, you must be realistic about them, too. You should also make them SMART, as I discussed in my article “How to invest in property by creating SMART objectives”.
SMART stands for:
For example, setting an objective of ‘I want enough to retire’ is not a SMART goal. It doesn’t answer any of the questions that it should. And because of this, you will be bound to fail. Instead, you should be able to provide a goal like this:
“I want to retire when I’m 60 (in 20 years), with an annual income of £25,000 in today’s terms. I plan to live in my current home and take two major holidays each year. I want my income to increase with inflation every year, and I want a legacy to leave to my children.”
This goal sets out your lifestyle goals perfectly. Before reading the rest of this article, spend a few minutes writing down your main lifestyle goal, and make it SMART.
Do you need income, capital growth, or both?
Having set out your lifestyle goals, you can now determine the type of investment return you need. For example:
- If you plan to take a sabbatical from work and spend three years studying for a degree, you will probably need an investment that produces income during those three years
- If you want to build a pot to leave to your loved ones when you die, you will probably be best investing for capital growth
- If you wish to pay off your mortgage early and benefit from an income that will allow you to work fewer hours, then you may wish to build a property portfolio that achieves both capital growth and income
Where does risk profile fit in?
OK, so you’ve set out your lifestyle goals and decided on the type of investment return you need to achieve them. Now you need to understand your risk profile. This will tell you more about the type of property investment you should make.
What is a risk profile?
A risk profile tells you how much risk you are willing (or able) to take to achieve your goals. There are two parts to your risk profile:
- Your ability to take the risk (or capacity to absorb short-term losses)
- Your comfort with risk (also called your ‘risk tolerance’)
Capacity for risk
Your capacity for risk is a financial measurement. It is best summed up by asking how much you can afford to lose. If you depend upon your investment to pay your living expenses, the answer would probably be “nothing”. If you have other income, then your capacity for risk is much higher.
Your capacity for risk may also be different according to the source of funds. For example, let’s say that you inherited £50,000. It’s money that you didn’t have before, and so won’t miss. You may decide to invest this money.
Putting such money down as a deposit on a property investment allows you to take advantage of the benefits of leveraging in property investment. You could turn this investment into a very valuable stream of income in later life, or, perhaps, invest for a capital gain to pay off the mortgage on your home sooner. Short-term losses on the invested amount won’t impact your current lifestyle financially.
While this pot of inherited money is available for investment, and losses won’t impact you, this may not be the case with other money you have. For example, let’s say that you have an education fund of £10,000. Although it is not achieving the returns it might, losing all or part of it would cause you financial distress and may mean altering the course of your life. On this money, you have no capacity for risk.
Your risk tolerance is measured by your emotional reaction to the loss of investment capital. This could depend on many factors: your age, health, marital status, whether you have children, your personality, and your investment experience.
If the market turns down, you may be the investor who decides to hold on to a property and even expand your portfolio. Or you may be the investor who prefers to sit tight and wait for more certainty in the market before investing, even if it means missing out on a couple of great opportunities.
Your risk tolerance can also be measured by what we call ‘the sleep test’. If you decide to invest and can sleep easily with that decision, then you should invest. If, on the other hand, the investment causes you to toss and turn, then it’s too aggressive for you and you should look for a more suitable investment opportunity.
That’s it for now! You’ve got a lot to think about. How about working on these three questions now:
- What are your lifestyle goals?
- What type of investment return will help you achieve those goals?
- What is your risk capacity and your risk tolerance?
In my next article in this series, you’ll learn more about investment risk. I’ll also introduce you to how to reduce your risk when you invest in property. In the meantime, if you’d like to discuss your lifestyle goals and how property investment could help you achieve them, book a property investment strategy consultation by contacting Gladfish today on +44 207 923 6100.
Live with passion and fun,