How to balance risk and reward to navigate volatility and achieve your goals

With a changing geopolitical landscape and technologies like AI reshaping almost every aspect of how we live and work, it can feel like change is the only constant. In this climate, it’s important for investors to go back to basics.

All investments come with risk, and ensuring your portfolio is structured to suit your needs is critical. Here’s a reminder of some key areas that can help you balance risk and reward in your portfolio.

#1 Know your risk profile (and stick it!)

How comfortable are you with potential losses? Your risk profile should consider your comfort with losing money, how much you can afford to risk, how losses will impact your plans today and, in the future, and how much time you have to recover from any losses.

Losses can be devastating for someone nearing or in retirement, affecting future income streams and potentially derailing retirement plans. If you’re in your 20s, you likely have your best earning years ahead, so you may be more comfortable taking risks.

That said, if it’s your preference, there is nothing wrong with taking a conservative approach to your funds, regardless of age. You may not get the growth that someone taking more risk might experience, but you also lower the probability of significant losses. It’s about what you are comfortable with, what you want to achieve and how long you have to get there.

Whatever your risk profile, it’s crucial to measure any investment opportunity against it to ensure it’s a risk you’re willing and able to take.

#2 Understand what you are investing in

When making any investment, regardless of the risk profile, it is important to understand how it could make you money.

Do you have a hypothesis for why its value will be greater in the future?  For example, a company’s cash flow, growth projections, expected growth in an addressable market or competitive advantage could all be reasons you believe it’s a worthwhile investment.

It can be easy to get caught up in hype, seeing other investors make significant gains, but if you don’t know how an investment will make money, you probably won’t understand how it can lose money either – and that’s critical.

Cryptocurrencies are a great example. Investment may look very attractive as some investors have seen impressive gains, but it is a speculative investment with significant risk.

If you don’t understand what a company does, it’s not a good idea to invest in it.  You can, however, look at it as part of an indexed ETF, so you are not as exposed. An indexed ETF can’t outperform the market, so your returns are limited but so, too, is your risk.

#3 Take a closer look when it seems too good to be true

If an investment offers you a significant return, ask yourself if its value is realistic.

A lotto ticket would look like a good opportunity if you looked at an investment purely on risk versus return; spend $10 for a potential return of $10 million. But we all know the probability is low, and the expected value of a lotto ticket is incredibly poor.

It’s critical to consider the likelihood of the projected gain materialising. If it seems too good to be true, chances are, it is.

#4 Diversify your portfolio

Diversification allows you to participate in the growth potential of different assets and markets, which can significantly lower risk, stabilise your portfolio, and protect you from volatility. It is an important part of any investment strategy, whether you take an aggressive, balanced or defensive approach to investing.

Consider your diversification across:

• Geography – ensuring your investments have a broad geographic spread can limit your exposure to the impact of any regional event, such as geopolitical tensions or natural disasters.
• Asset classes – different asset classes, such as shares, bonds, real estate, and infrastructure, often respond differently to the same economic event. When one asset class is underperforming, another might outperform, which can help stabilise your portfolio's overall returns.
• Industry – different industries will be impacted differently by the same economic event, from the geopolitical climate to regulatory changes, technological advancements and consumer trends, so you aren’t overexposed to any one industry.

#5 Stick to your investing framework and principles

At the end of the day, investing in any environment comes back to having a solid investing framework, and it is critical in volatile, uncertain, complex and ambiguous environments.

So, go back to basics. Check alignment with your risk profile, know what you are investing in and why, and diversify, diversify, diversify.

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General Advice warning

The information provided in this blog does not constitute financial product advice. The information is of a general nature only and does not take into account your individual objectives, financial situation or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice. Apt Wealth Partners (AFSL and ACL 436121 ABN 49 159 583 847) and Apt Wealth Home Loans (powered by Smartline ACL 385325) recommends that you obtain professional advice before making any decision in relation to your particular requirements or circumstances.