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How much return can you expect? How do I know how much investment risk I’m comfortable taking?
Tanja Eronen, Managing Director of Nordea Funds Plc, answers these questions and explains more about risks, returns and the investment horizon.
More and more people are becoming interested in investing and some even get hooked on following the markets and their events and keeping track of how they develop as an investor.
“If we compare investing to exercise or sports, some people enjoy taking a quiet evening stroll in the woods, whereas others prefer to push themselves to the limit in a really technically demanding sport. There are many way of investing, some of which are as easy as an evening stroll, while some are really technical disciplines, such as direct stock picking. Before delving into the technical side of things, it’s worth practicing your technique to avoid unpleasant surprises. And just like exercise, investing can lead to injuries if you try something technical without the necessary know-how,” Eronen explains.
Risk versus reward
Currently investment returns are low, but 5–10 years ago investors could expect much better returns.
- The return expectation is less than 1% for extremely safe investments and potentially 2–4% for investments with an average risk.
- If you are a high-risk investor trading in equities, your rate of return could be above 4%.
All of these are long-term expected returns because your investment horizon should usually be more than six years. You should carefully consider how much return you aim for and what is the risk involved, and whether you’re comfortable taking on such a risk. One way of reducing the risk in your portfolio is through diversification.
“If we go back to the exercising metaphor, you can think about investing as power training versus endurance training, and it depends on your personal goals how much you should do either. But usually the recommendation is that a long-distance runner should also do a little bit of muscle training as well. In investing, the same division applies to equities and bonds. If you can tolerate a lot of risk, you can focus on equities, but if you can’t handle risk, you should mainly invest in bonds. But the main thing is that you have both asset classes in your portfolio, and that you don’t invest in just two different stocks but in many and in every major market across the world. That’s how you can avoid excessive risks,” Eronen says.
Risk with a long-term approach
It may be difficult to estimate your personal risk tolerance. You can get an indication of it if you think about what you would do as an investor if the markets were to crash. Would you panic and start selling? If yes, then this is usually a sign that risky investments are probably not for you.
“However, if you remain calm and composed and keep your focus on your goals 10–11 years from now, remaining confident that a market slide will eventually be followed by a rally, this usually means you can endure risk. The state of your personal finances is also a factor. If you’re an entrepreneur with highly irregular income, it might be better to avoid taking on too much risk. But if you’re employed in a very stable profession with a low rate of unemployment, you can take on much more risk in your pension investments, for example,” Eronen advises.
If you’re interested in increasing your investing and financial stamina, you can get your own personal trainer in the form of an investment adviser so you can prepare your personal training programme, i.e. an investment plan. The easiest way to start is by investing in a balanced fund. It comes with a dedicated personal trainer because it’s run by a professional portfolio manager, who takes care of everything.