What is a risk profile?
With some providers, you choose a risk profile. That profile often determines the mix between stocks and bonds. Stocks can swing more in value, while bonds usually fluctuate less. So the more you invest in bonds, the lower the risk profile — but also the lower the expected return.
Investing in stocks is best done for at least ten years
Stock prices go up and down. When prices are low, you don’t want to be forced to sell your investments — you want to be able to wait calmly until prices recover. That’s why investing in broadly diversified stocks usually works best with money you can leave untouched for a long time — preferably ten years or more.
But what if you need the money in 5 years?
If you want to buy a car in five years using (part of) your savings, what you want most is certainty that the money will be there then. So does it make sense to choose, for example, a “medium” risk profile, where half of that money goes into bonds and half into stocks? No. Because there’s a real chance that in five years the stock market is down 30%, and bonds likely won’t be able to make up for that. Yet some providers suggest that with a mixed portfolio and a lower risk profile, you don’t need such a long time horizon. That’s how a risk profile can give you a false sense of safety.
So how do we do it?
We keep it simple with one question: How much money might you need within the next 10 years?
Money you’ll need within 10 years: save it in a savings account if you need it in the short term, or invest it in a bond fund.
Money you can leave untouched for longer than 10 years: consider investing in stocks (as with UpToMore, where we invest in stocks through ETFs).
Also read: “Investing or saving”.
The difference between saving and investing in bonds
Saving and investing in bonds both have relatively low risk compared to investing in stocks — but there are important differences:
Saving has inflation risk (interest is usually lower than inflation, although it tends to follow inflation over time). In short: there’s a good chance your savings will buy less and less.
Bonds have two risks: interest-rate risk (when interest rates rise, the price of a fixed-rate bond usually falls, while savings rates often rise gradually) and counterparty risk (the bond issuer — a company or a country — can run into financial trouble or go bankrupt, meaning you could lose part of your money).