The choice of investments in your portfolio will have a significant impact on your ability to carry out your projects.
- A portfolio that is too conservative will offer a return that may be too low.
- An overly aggressive portfolio will cause you to experience periods of instability, which may be stressful and prompt you to sell at the worst possible time.
At fdp, we identify the optimal portfolio for each client based on a structured and rigorous process.
Determine your objective
Retirement is the most common goal, but we see that investors can have more than one goal. We must therefore determine the importance of each, both qualitatively (order of importance) and quantitatively (real cost).
Understand the nature of the markets
The basic principle is that any investment in the stock market involves risk. This stock market risk can result in a drop in the value of your portfolio.
The more comfortable you are with risk, the higher your potential long-term return will be. With this in mind, it is essential not to deviate from your investor profile.
React to risk
Two factors are key in determining your optimal portfolio.
- The first is your risk capacity. This element is relatively easy to quantify.
- The second is your risk comfort level, or more simply, your aversion to losing money. This factor should also be quantified, but it is often times of turbulence that reveal your risk comfort (or discomfort) level.
If the assessment of these two factors turns out to be contradictory, the result indicating a propensity to take less risk should be favoured. However, be sure to speak with your advisor to clarify certain points and thus better align your portfolio.
In summary, you should opt for an investment portfolio that maximizes the potential long-term return, while reflecting your risk tolerance.
First step: define your risk capacity
Your investment horizon is based on the number of years it will take to achieve your financial goal. Even if you don’t know the exact year you will reach your goal, your risk capacity is directly related to the number of years you will stay invested before you achieve it. The longer your investment horizon, the better you will be able to navigate turbulent environments.
Your investable assets (excluding your real estate, for example) must also be taken into account. The higher the value of these assets, the greater your risk capacity.
Your savings capacity is an important factor.
- If you are in a period of strong accumulation, a dip in the markets could be favourable to you since you will be able to reinvest at lower prices.
- If, on the contrary, you need recurring income, it will be more difficult for you to take risks because you don’t have the capacity to reinvest when the markets fall.
The stability of your income dictates your capacity to take risks.
- For an established professional with stable income, it is easier to make a budget they can stick to.
- In addition, the savings capacity of an investor at the start of their professional career is more uncertain and they may even have to dip into their savings to offset a temporary shortfall.
Your investment knowledge helps you better assess the risk involved when you invest. Understanding the difference in risk between stocks and bonds (or any security guaranteed by a government or a financial institution, such as guaranteed investment certificates or corporate debt securities) is a good place to start. This knowledge enables you to better cope with the volatility of your investments since you know that fluctuations are part of investing in the stock market.
Second step: determine your comfort level with portfolio risk
Your investment objective is important because it dictates the ultimate purpose of your investments.
- If capital protection is paramount, your investments should focus primarily on government-guaranteed securities, with perhaps a few corporate bonds, which will provide little return.
- Conversely, an investor who aims for maximum growth, without worrying about short- and medium-term fluctuations, will be able to maximize their potential return.
To complete your profile, it is important to examine your behaviour in market downturns. Incurring a loss of $2,000 on a fictitious $10,000 portfolio may seem acceptable to you, but if your actual assets of $800,000 drop by $160,000, that could be untenable for you.
How do you react?
- Do you call your advisor as soon as you see a 10% drop in your portfolio, or do you wait for your periodic meeting?
- In a downturn, do you contact your advisor to sell quickly or, conversely, do you reinvest some cash that you currently have on the sidelines?
Visualizing the situation with the help of charts of historical returns that identify the start point, the end point and the potential fluctuations that may occur could prove very helpful in making the right decision.
Rigour and transparency
The complex and meticulous process of determining your investor profile optimizes the likelihood of achieving your financial goals and obtaining the maximum return based on your risk tolerance.
Obviously, your personal or professional situation constantly evolves and, in the event of major changes, it is important to notify your advisor so that your investor profile is reviewed accordingly and adjustments are made to your investment portfolio, if necessary.