Don't be this investor

It depends what kind of investor you are.

Risk profiles and calculations can give you an indication of risk tolerance. But it is not until you get a decent market downturn that you really see how risk-tolerant people are.

Who is this for

I'm talking to the growth investors out there. These investors want to use the stock market to grow capital over time. They aren't traders, jumping 100% in or 100% out of stocks. Nor do they want to be 100% term deposit holders. They are the investors willing to risk capital to get a better return, but they are just not sure how much.

What type of growth investor are you

In the category of investors who are looking for growth, we effectively have two types:

Type 1: Investors who want just stocks. These investors keep investing throughout the cycle. They ride out any falls with the view stocks will eventually win out in the long run.

Long-term returns on stocks are 6-9% with 15% volatility.

This means your range of returns in a typical (two standard deviation) year is between -24% and +39%. And, stock returns are not normally distributed, so the real range is even wider.

But, over the long term, stocks perform better than other assets. Eventually you end up in front:

Type 2: Investors who still want growth but are willing to wear a lower return in order to dramatically reduce the volatility. These are multi-asset investors.

Because they are buying lower-risk assets, the returns will be lower. Say we take a growth portfolio of 80-85% stocks and 15-20% cash and bonds. That will lower your long-term returns by about 0.5 to 1%. Call it 5.5-8% per annum. But, if managed well, you can cut your volatility in half.

Now, your (two standard deviation) range of returns in a typical year is between -9% and +22%.

And you might not even be 0.5 to 1% behind. Potentially, with some well-timed tactical asset allocation, you can make up a lot of the difference in returns for much lower risk.

The number one problem

Many people say they are Type 1 when markets are going up, but when markets go down, they suddenly want to be Type 2...

And, in my experience, these investors have the worst outcomes because they switch between strategies at the wrong time. Type 1 after markets have boomed, and so they get all the downside when stock markets bust. Then they switch to be Type 2 and miss some of the upside.

Should you keep investing now?

• If you are Type 1, unless you think this financial armageddon, stay invested, keep adding to the portfolio over time and ride it out.
• If you are Type 2, hopefully you are already in a tactical fund that reduced stocks earlier this year. Now it is about working out how to time the bottom. Personally, I'm not ready yet. But I am watching closely.

You also don't have to pick just one strategy. But beware of switching your weights. If you gave 50% to a stock fund and 50% to a tactical asset allocation fund, keep rebalancing back. If your stock fund booms and turns into 60% of your portfolio, add new money or dividends to your tactical fund to even it out. Given the current stock market rout, there will be a time to do the opposite: take from your safer fund and add to your stock fund.

Net effect

I'm not saying you should never change between the two types. But don't kid yourself that you are applying a long-term investment strategy if you keep switching between different long-term strategies.