WHAT TO OWN · LAYER 2
Understanding Risk vs Reward
Risk comes from not knowing what you're doing.
— Warren Buffett
Learn how to match your investment strategy to your personal risk tolerance, time horizon, and financial situation.
This Page Takes: 25 minutes
Why This Matters
There's no one-size-fits-all investment strategy. Your ideal portfolio depends on your age, goals, income stability, and emotional tolerance for market swings. This page helps you understand your risk profile and choose appropriate asset allocations.
Volatility vs Actual Risk (They're Not the Same)
Most people confuse volatility (price fluctuations) with risk (permanent loss of capital). Understanding the difference changes how you invest.
Volatility
Short-term price swings. Your portfolio value goes up and down daily, monthly, yearly. It feels uncomfortable but isn't necessarily dangerous.
Example: Australian stocks can drop 10-20% in a bad year, but historically recover and grow over 10+ years.
Actual Risk
Permanent loss of capital. The investment never recovers, or you're forced to sell at the worst time because you needed the money. This is true risk.
Example: Investing in a single company that goes bankrupt. Or needing to sell stocks during a crash to cover living expenses.
The Key Insight
If you have a long time horizon (10+ years) and don't need to touch the money, volatility isn't risk — it's opportunity. Market crashes are when you buy assets on sale.
But if you have a short time horizon (under 5 years) or unstable income, volatility becomes risk because you might be forced to sell at the wrong time.
Warren Buffett's Wisdom
"The stock market is a device for transferring money from the impatient to the patient." If you can tolerate volatility and stay invested, you benefit. If you panic-sell during crashes, you lock in losses.
Why Time Horizon Is Everything
Your time horizon — how long until you need the money — is the single most important factor in determining how much risk you can take.
Short Term (0-5 years)
House deposit, wedding, car purchase
Strategy: Focus on capital preservation. You can't afford a 30% crash right before you need the money.
Suggested allocation: 60-80% bonds/cash, 20-40% stocks, minimal volatile assets
Medium Term (5-10 years)
Kids' education, investment property
Strategy: Balanced growth and stability. You can ride out one market cycle but can't wait forever.
Suggested allocation: 50-60% stocks, 30-40% bonds, 10% gold/alternatives
Long Term (10+ years)
Retirement, generational wealth
Strategy: Maximise growth. You have time to recover from crashes and benefit from compound returns.
Suggested allocation: 70-85% stocks, 10-20% bonds, 5-10% alternatives (gold, crypto)
The Math Behind It
Over any 1-year period, Australian stocks have been positive 70% of the time. But over any 15-year period, they've been positive 100% of the time since 1900.
Time smooths out volatility. The longer you can wait, the more risk you can afford to take — and the higher your expected returns.
What Determines Your Risk Tolerance?
Beyond time horizon, several factors shape how much risk you can and should take.
Income Stability
Stable PAYG salary = more risk capacity. Variable income or self-employed = need more stability in portfolio.
Emergency Fund
Solid 6-month emergency fund = can weather volatility. No buffer = forced to sell at worst times.
Financial Obligations
Large mortgage/dependents = less risk capacity. Low obligations = can handle volatility better.
Emotional Temperament
Can you sleep when portfolio is down 20%? Or will you panic-sell? Honest self-assessment matters.
Investment Experience
First-time investor = start conservative, learn gradually. Experienced = can navigate volatility.
Goal Importance
Retirement (essential) = can't risk too much. Holiday home (nice-to-have) = can take more risk.
Discover Your Risk Profile
Answer these 7 questions honestly to determine your recommended asset allocation.
1. What is your age?
2. When do you need this money?
3. How stable is your income?
4. Do you have a fully-funded emergency fund (6 months expenses)?
5. If your portfolio dropped 30% tomorrow, what would you do?
6. What's your investment experience level?
7. What are your current financial obligations?
Adjust Your Allocation Based on Cycles
Your risk profile determines the general framework, but smart investors adjust allocations based on where assets sit in their historical cycles.
The Wealth Cycles Approach
Increase Allocation to Undervalued Assets
When an asset class is historically cheap (e.g., at the 10th or 20th percentile), consider increasing your allocation within your risk tolerance. This is when you're buying at a discount — the best time to accumulate wealth.
Example: If you're "Moderate Risk" with 30-40% stocks recommended, but stocks are at the 5th percentile historically, you might increase to 45-50% to take advantage of the opportunity.
Reduce Allocation to Overvalued Assets
When an asset class is historically expensive (e.g., at the 90th or 95th percentile), consider reducing your allocation. Selling strength and locking in gains is how wealth is preserved.
Example: If stocks are at all-time highs (95th percentile), you might reduce from 40% down to 25-30%, shifting the proceeds into undervalued assets like precious metals or cash.
Use Historical Context
Markets move in cycles. Understanding where each asset class sits historically helps you foresee likely trends. Assets that have been suppressed for decades (e.g., gold relative to stocks) tend to revert to the mean eventually.
Your allocation should reflect:
- • Your risk profile (the framework from this page)
- • Current cycle positioning (see our Cycle Indicators)
- • Your own research and conviction about specific assets
- • Your time horizon and goals (from Layer 1: Foundations)
Static allocations work for the average investor. Dynamic, cycle-aware allocations build exceptional wealth.
Learn the Framework
To truly understand cycle-aware investing, you need to learn the patterns, historical data, and economic drivers behind market cycles. That's what Layer 3 (Why It Works) is all about.
Start Wealth Cycles Education →Tax-Smart Execution: Borrow, Don't Sell
Now that you know your risk profile and allocation, learn how to access liquidity without triggering CGT.
In Layer 4 (How To Execute), we teach an advanced strategy used by the wealthy:
- • Borrow against your holdings instead of selling them
- • Avoid triggering CGT (loans aren't taxable income)
- • Keep your allocation intact and benefit from future appreciation
- • Interest may be tax-deductible if used for investments
Example: Sarah borrowed $75k against Bitcoin instead of selling. She avoided $4,625 in CGT and still owned all her Bitcoin when it doubled. Learn how she did it.
Available in Layer 4: Advanced Strategies
What To Own - Risk vs Reward: Complete
- Volatility (short-term price swings) is not the same as risk (permanent loss of capital). Time horizon transforms volatility into opportunity.
- Your risk tolerance depends on three factors: age/time horizon, income stability, and emotional capacity for drawdowns.
- Asset allocation should match your risk profile—aggressive for young professionals with stable income, conservative for near-retirees.
Homework
Complete the risk assessment quiz above honestly. Does your current portfolio match your risk profile, or are you taking too much (or too little) risk for your situation?
Write down your target asset allocation based on your risk profile. Compare it to your current allocation. Identify the top 2 adjustments you need to make and create a 12-month plan to rebalance toward your target.
What's Next?
15 minutes