Using the Risk Manager you can visualize and understand how risk works when investing in a portfolio of products. The tool will show you what your optimal return should be in order to minimize your downside risk such as not to be bankrupt before the end of your life.

A scenario analysis will quickly show you that a safer portfolio might not turn out to be safe enough based on your contribution rate, a little more aggressive portfolio might get you out of trouble. However, beware, the more aggressive your portfolio, the more risk you take. And just maximum risk is not the solution, because then you risk of losing everything. I will expand more on how tricky a risky portfolio can be, but that will be in a following post. For now, the point is to understand that returns come with risk.

The way return is related to risk is depicted in the figure below. This is a graph commonly used in finance, where return is function of risk, and the curve shown in the figure represents the efficient frontier. Basically, it says that you cannot end up above this curve with a portfolio of financial products (unless you use leverage).

 

The blue dot on the left marks the zero risk investment bonds, or T-Bills from the US Treasury.

The efficient frontier is a very important achievement in finance, because it will tell you what portfolio of products you should invest in depending on your risk profile. As such, understanding your personal risk profile is the most important aspect of building your portfolio, because everything else will be defined by it. The returns are a function of the risk you are comfortable with, and the portfolio is then extracted out of the market data. Any change from that optimal portfolio is fine tuning based on your views, opinion and expectation on how the market might evolve.

Personal finance is therefore a trade-off between risk and return, the lower the risk you are comfortable with, the lower the expected return.

Join us for our seminars and talks to hear more about how to assess risk in personal finance to better protect your investments!