Investment Risk: the learn, the burn and the bonus
The reason many people shy away from investments and rather choose the traditional route of savings in the bank, is because they fear the risk factor. We are assured that in a savings account our money won’t go ‘down’ – and when things look rosy we’ll get a bit of interest indicating growth. However, what we don’t realise is that inflation and other factors may simply keep our money running on the spot. It might look as though numbers have increased but the value has in fact diminished. Investment with all its attendant risks is ultimately the more advantageous route.
The learning curve – the good, the bad and the necessary
The spectre of loss will always loom with investments. There is as much likelihood of loss as there is any expected return on any particular investment. The trick is not to see this as a negative but rather as an inseparable part of the process and to accept it as such. Understanding risk is one of the most important parts of a financial education.
There is ‘no pain, no gain’ with regard to investing – loss is something you must factor in along the way. A common definition for investment risk is that it is a deviation from an expected outcome. That deviation can be positive or negative; to achieve higher returns in the long run you have to accept volatility in the short-term. How much volatility you are prepared to accept will depend on your tolerance for risk, meaning you will have to examine your capacity and propensity for dealing with uncertainty – in other words understanding your own psychological comfort levels in handling the potential of loss.
Merely understanding how your own psychology influences the way you invest is not the end of the story. There is a field of investigation into investors’ mindsets known as behavioral finance which has highlighted how people view gains and losses. What they’ve found is that most investors exhibit loss aversion rather than risk aversion – in other words, they put more weight on the pain associated with a loss than any good feelings associated with a gain.
Burning issues – cost and unpredictables
In general the more you are prepared to risk, the more you will pay a fund manager to manage that risk. The higher your exposure the more costly it becomes. The level of risk associated with a particular investment typically correlates with the level of return the investment might achieve. The more you stand to lose, the more you will stand to gain. The rationale behind this relationship is that investors willing to take on risky investments and potentially lose money should be rewarded for their risk.
Risk also lies in events outside of the investment itself. It’s one thing to tread the ups and downs of the market with some trepidation – but another when life catches up with you and you may be forced to sell stocks during an economic downturn, or prop up the aftermath of a job loss, or pay unforeseen medical bills or your child’s college education. Sometimes risk lies less with the investment itself, but rather with your staying power. Do you have the tenacity and circumstances to remain invested over an extended period of time?
The bonus of self-knowledge
If you’re a ‘keep it in the bank where it’s safe’ kind of person, then investing isn’t for you. Leaving money in risk-free high-yield savings accounts isn’t investing at all. If you prefer to keep the bulk of your wealth in a savings account then you’re practically guaranteeing loss of purchasing power over the long-term due to the rising costs of goods that you might buy with that money. Likewise, investing is also not for the investor who is reckless and demanding. No investment is without risk – nor without patience.
Market fluctuation: At any time the overall economic condition of the country or even the world, can cause your investment to fall.
Time: How long are you prepared to leave your money? The breakpoint is a 10-year horizon. Higher risks are generally safer risks beyond the ten year span.
Work: What risk does your job hold? How many children do you have? Do you have any child with special needs? How steady is your marriage? All that determines whether you may need to access your money sooner that the advised ten year plan.
Values: Risk matches your values – in essence who you are. It goes about who you are and what is important to you. Is it dreams you’re saving for, or long-term security for your family? It comes down to whether you’re cautious or adventurous, responsible or easily influenced by change. Knowing yourself best, is the best way to handle risk – and to free yourself from anxiety about investing.
Risk tolerance: Determining your risk tolerance—generally defined as the ability to stomach large swings in the value of your investment portfolio—is an important component of investing. If the goal is to make sure the money you need is there when you need it, accurately assessing your risk tolerance should be done before you figure out what investments belong in your portfolio. Planning, patience, risk acceptance and a wary eye, are the bonus cards in your pack.
Risk and peace of mind
At Foster Wealth we’ve been settling the nerves of nervous investors for years. That’s because we understand the desire for balance between concern and growth. Risk assumed, measured and managed is often hardly risk at all. But it is a constant element that is not always ours to control. Patience and persistence in the face of a volatile, yet ever-upwardly mobile stock market is how we have developed our highly professional and personalised approach to preserving capital and beating inflation, and meeting our clients’ needs with care and consideration for their vision, values and individual risk aversion.
Find us at: www.fosterwealth.co.za