Goals & risk tolerance

Choosing investment goals

You can't choose the right investment strategy until you're clear about your investments goals and timeframe. Working out your goals will help you identify the types of investments that are suitable for you and how much risk you can take. 

Set your investment goals

Investing is about putting your money to work to achieve your personal goals. So start by identifying what you want to achieve by when. Setting goals forces you to plan, and having a clear goal - ideally written down - helps motivate you to stick to your plan.

Think about your goals first. Perhaps you are saving for a holiday, for a home deposit or to pay for a child's education. Or your goal may be to boost retirement savings. You can then see that different goals have different timeframes. You may only have 6 months or a year to save for a holiday but if you are saving for your retirement you might have 25 or 50 years.

Setting a timeframe for each goal helps you stay on track. You may have several goals, each with a different timeframe. Allocating a timeframe to each investment goal will enable you to think about how much you can afford to invest and how long it will realistically take you to reach your goal.

Sample goals and timeframes

Goal

Short term
(up to 3 years)

Medium term
(3-7 years)
Long term
(more than 7 years)
Holiday $3,000    
Save for child's education   $40,000  
Boost retirement savings     $100,000
When do you want to spend the money In 2 years Starting in 5 years Starting in 25 years

Set your timeframe

Setting a timeframe for each goal will help you work out how much investment risk you can afford to take.

If you are saving money over a short period of time it may be tempting to use higher-risk investments. But growth investments, such as shares, are not appropriate for short investment timeframes as their value might drop suddenly, just when you need your money.

But if you are saving for a long-term goal, such as retirement in 25 years, then you have time to ride out the ups and downs in the market. This means you can take on a higher level of investment risk.

Video: How to set investment goals and deal with risk

Video about how to set investment goals and deal with risk with Nicole Pedersen-McKinnon.

Nicole Pedersen-McKinnon talks about setting investment goals and working out your risk tolerance.

Transcript: How to set investment goals and deal with risk

How do you feel about risking your money?

Risk tolerance also depends on your ability to cope with dips in the value of your investments. Factors that can influence your risk tolerance include your age, your ability to recover from capital losses and your health.

To decide where you fit on the risk tolerance scale, ask yourself this question: 'How would I feel if I woke up tomorrow and found my investment balance had dropped 20%?'

If this drop would cause you to worry a lot and pull out of the investment, then a high risk investment is not for you. This is because you could pull out at the worst possible time and actually compound your losses.

If, on the other hand, a drop in the market causes you to start looking for bargain buys, then you are probably very comfortable with market fluctuations. You will be comfortable with a higher level of investment risk.

Your comfort level could be somewhere in between.

How much risk should you accept?

Your overall risk tolerance is the lesser of the risk you are comfortable with and the risk your timeframe will allow you to take. Use the investment grid below to work out where you fit on the investment risk scale. Cash is low risk and growth is high risk.

Your partner may not have the same risk tolerance as you. If you are considering a joint investment, you may need to compromise on an investment option you are both comfortable with.

How comfortable are you?
Cash investments are best if you have a 1 to 3 year investment horizon. For 4 to 7 years, a balanced investment might be better, unless you are very stressed about your investment in which case a conservative option is recommended. For more than 7 years, a growth investment is appropriate if you are relaxed about taking risks, otherwise a balanced option carries less risk, or a capital stable option if you want relatively little risk.

What we mean by growth, balanced and conservative

When we use 'growth', 'balanced', 'conservative' and 'cash' here, this is what we mean.

  • Growth - invests 70-90% in shares or property. Aims for higher average returns over the long term.
  • Balanced - invests 50-70% in shares or property, and the rest in fixed interest and cash. Aims for reasonable returns, but less than growth funds to reduce risk of losses in bad years.
  • Conservative - invests 30-50% in shares and property with the majority in fixed interest and cash. Aims to reduce the risk of loss and therefore accepts a lower return over the long term.
  • Cash - invests 100% in deposits with Australian deposit-taking institutions. Aims for stable returns over a short term.

Different funds may have different names for their portfolios and asset allocations may not be the same as ours. Read the fund's PDS to find out how money will be allocated for each investment option.

Case study: Carissa plays it safe

""Carissa is studying and working part-time. She is saving for a post-graduation trip but is extremely cautious and doesn't want any risk of losing her capital. She is happy to accept a steady rate of return from a high interest online savings account.

'I may not be getting the same returns as a share investment in the good times but I want to take this holiday when I graduate in 2 years time, so preserving my capital is my main concern. The share market? Not at the moment. I don't have time to get back any losses.'

You've identified your goals, know your timeframes and considered your risk tolerance. Be aware that borrowing to invest adds even more risk to a strategy. While there is potential to greatly increase your returns there is also a risk that you will greatly increase your losses.

 Next, learn more about risk and return.


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Last updated: 09 Sep 2016