What is your attitude to investment risk? What does it mean? What is volatility?

Without being able to answer these questions, investing will become more of a gamble instead of a well thought out structured process.
So how do you find out what your attitude to investment risk is?

You need to understand what you are looking to achieve with your investments before you can really answer this. It is possible for one investor to have many different attitudes to risk, depending on his or her objectives. Let us try to clarify.

It is generally accepted that low risk equals safer but lower returns and conversely higher risk is normally associated with higher potential returns. You therefore need to establish the correct balance of investments to suit your individual objectives.

Assume you have a fund of money which is used for your retirement income; chances are you will want to adopt a very conservative approach. Why? Because your investment objective would be to preserve the value of your investment whilst maximizing the potential income generated from it. The last thing you need to happen to a very important fund such as a retirement fund is to lose capital value. Therefore, you would not invest it in say technology, warrants or emerging market funds; the reason for this is that your attitude to risk is cautious. You would probably look towards fixed interest securities, government bonds and/or annuities.

Now let''''s assume that you had $10,000 left from your income and all your other savings and investments and catered for. You can afford to take higher risk for potentially higher returns. If the strategy goes wrong, it will not affect your standard of living or your other investments and savings. In short, you should only invest in higher risk investments with money that you can afford to lose.

For most investors however, they want a broad spread of investments that are an alternative to deposit based savings. With this in mind, you should decide what spread of investment types and risk profiles would best match both your investment objectives and attitude to risk.
Attitude to risk is normally expressed on a scale of 1 to 10. With 1 representing very secure investments such as bank accounts or Treasuries and 10 representing higher risk investments such as direct equities, options and very exotic funds.
When asked this question most investors respond by saying that they are a 5 on the scale of 1 to 10.
This does not mean that you should invest into this category alone. You should aim to have your investments spread across a range, from say 3 to 8 but with the overall portfolio representing a 5. Why? Because this spread of asset classes will give you a great deal of diversification and market exposure with an aim to reduce your overall volatility.

Volatility

Volatility is a measurement of the change in price (fluctuations) over a given time period. It is usually expressed as a percentage and computed as the annualized standard deviation of the percentage change in daily price.

The more volatile a stock or market, the more money an investor can gain (or lose!) in a short time.

In referring to mutual funds, volatility (Standard Deviation) is the measure of the degree to which a fund''''s return varies on a day-to-day or month-to-month basis.

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Standard Deviation (volatility)

Standard Deviation is a statistical term that provides a good indication of volatility. It measures how widely values (closing prices for instance) are dispersed from the average. Dispersion is difference between the actual value (closing price) and the average value (mean closing price). The larger the difference between the closing prices and the average price, the higher the standard deviation will be and higher the volatility. The closer the closing prices are to the average price, the lower the standard deviation and the lower the volatility.

From the above it can be seen that two funds can return an equal amount (say 10% over 12 months) but both have very different volatility levels/standard deviations ratings.

In general terms, a fund that has a high volatility or standard deviation rating will be considered higher risk, why? Because it can quite easily lose any potential returns it has made due to the volatile nature of the fund. Therefore, cautious investors should pay particular attention to the volatility and standard deviation of a fund.

Please note that all the information contained relating to attitude to investment risk is purely for indication purposes only.

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