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Risk Profiles & Volatility

Risk Profiles & Volatility. Investment Risk Profiles are all about people’s ability to accept the unpredictable and sudden downward (and upward) shifts that occur in an investment’s value. The underlying concept is tolerance of volatility. Low Volatility Example.

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Risk Profiles & Volatility

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  1. Risk Profiles & Volatility Investment Risk Profiles are all about people’s ability to accept the unpredictable and sudden downward (and upward) shifts that occur in an investment’s value. The underlying concept is tolerance of volatility

  2. Low Volatility Example • This example has low volatility • Annual returns are about 6%, plus or minus 3% • We say low volatility because shifts in value (3%) are lower than the average value

  3. High Volatility Example • This example has high volatility • Annual returns are about 15 %, plus or minus 30% • We say high volatility because shifts in value (30%) are larger than the average value

  4. Volatility - Combined Examples • Here are both the low and high volatility examples • The low volatility one doesn’t have large drops & rises in value Which one of these would you prefer to invest in?

  5. Volatility - CumulativeEffect • Another way to look at volatility is the cumulative totals of yearly values • That is: Year 1, then Year 1+2, then Year 1+2+3, etc

  6. Volatility & Wealth Buffer • High volatility investments provide the opportunity to buffer • Protect investment value when large negative shifts occur Wealth Buffer

  7. VOLATILITY - Points to Note • Volatility refers to unpredictable upward and downward shifts of value • Often called the investment “Risk” • low volatility  low returns • high volatility  low or medium or highreturns (return received depends on investment's underlying quality) We need to determine your tolerance to volatility “Risk Profile”  Investment Strategy

  8. VOLATILITY - Risk Spectrum We have considered two extreme cases for the risk profile: • Defensive profile • High-Growth profile

  9. VOLATILITY - Risk Spectrum • In reality, there is a continuum of Risk Profiles, from Defensive to High Growth • Middle Risk Profile is “Balanced” • Note higher return is expected with higher risk profile

  10. Volatility & Investment Timeframe • The amount of time over which you are investing has a major control on Investment Strategy (together with your tolerance to volatility) • Usually: Short-term (1-3 years)  low volatility investment Long-term (5-7+ years)  higher volatility investment Note that highervolatility means tolerance is higher than short-term tolerance (eg short-term may have Defensive strategy, long-term may be Balanced or Growth or High-Growth strategy)

  11. Volatility - What Causes It? • The amount of volatility is determined by the proportion of Income Type investments to Growth Type Investments • Income Type investments are: • cash • short-term deposits • long-term deposits (“bonds”) • Growth Type investments are: • Property (residential & commercial) • Australian shares • International shares

  12. Volatility - What Causes It? • The amount of volatility is determined by the proportion of Income Type investments to Growth Type Investments Usual investment strategy is to make a mixture (“Portfolio”) of appropriate amount of Income and Growth assets.

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