Risk is a scary word to the average person.
In investment, however, there is no potential reward without risk.
The higher the risk the higher the potential reward. Conversely, the lower the risk the lower the potential reward. The equity markets are a risky place, and they favour those who invest for the long term. This has been proven over and over throughout the history of markets.
Evidence shows us that the longer you’re looking to invest, the more ups and downs you can weather as the market will always return to the mean. If you’re looking to invest short term, taking on more risk is probably not your best option – which is why we always say you should start as soon as you can, to give yourself that cushion of time.
Those who are risk-averse may think that they’re better keeping their money where they can see it (in the bank), or dabbling in some DIY investments, or entrusting their funds to active management for a ‘hands on’ approach.
Let’s break down those options.
KEEP IT IN THE BANK
The interest you get from the lump sum in your bank account is not likely to keep up with inflation over time – a fact we should all be painfully aware of in our current inflatory environment. A term desposit may gain you around 1-3% interest per annumi, but if inflation is rocketing up to 7.3% like it is now, your savings today are already losing buying power for tomorrow.
If you’re looking to put money away for retirement or other long-term goals years away, you have the time to take on more risk. You don’t have to – but it’s something to consider when you’re assessing whether your money is working as hard as it could be.
DIY MANAGEMENT
This can go right, but it can also go spectacularly wrong.
Sharesies and other DIY platforms are pretty popular these days. You might have heard the term micro-investing coming up in the past year or so. It’s the idea that through online investment apps and platforms, you can essentially create a digital piggybank with your spare change. Micro-investing advocates tout it as a way to dip your toe into investing, with the small amounts you’re putting in generally meaning you won’t be too upset if the market doesn’t move the way you want it to.
The risks in this kind of investing are the same whether you’re putting in a lot or a little – speculating on low-cost investments is more like buying a $2 scratch card, because it feels less of a commitment than laying down money at the racetrack. You’re still taking a gamble, and you’re not mitigating risk so much as the overall dollar value on the line.
ACTIVE MANAGEMENT
Short-term speculators are notoriously bad at beating the market over the long haul. Past returns are not predictors of future performance.
Recent data from our partners at Dimensional Fund Advisors proved this again through an analysis of US stock market returns, which showed there was no meaningful relation between market volatility and managers’ success rates. The implication is that traditional active investments may actually compound your concerns during a time of market volatility – so on top of not being able to predict performance, active management will likely stress you out as well.
Volatile market environments give us enough to worry about – investors can do without unpredictable outcomes from traditional active management.ii
In terms of what volatility means to you as an investor, consider the following:
1.) Think ‘time in the market’, not ‘timing the market’. This is an old adage for financial success and has been proven right many times.
2.) Don’t act on emotion. Not only will it increase your stress level, but ultimately it won’t get you ahead. It may feel wrong to hold your nerve while the market changes. The only thing more distressing than watching the market tumble while you’re in it? Watching the market fly upwards when you’re not in it.
Invetsment portfolios should be built with a variety of asset classes to support long term goals and plans. They are rebalanced based on market targets or weighting changes. They should take into account various scenarios to ensure there is no need to panic and if someone is drawing down, spending is accounted for in the short term.
No one’s crystal ball gazing has been able to predict the future yet. But with a strong, evidence-based financial plan, you can account for the ups and downs (and what your best course of action in these times is). If you’re looking to sort your financial road map, sitting down with a trusted financial adviser is a great place to start.
Nick Stewart is a Financial Adviser and CEO at Stewart Group, a Hawkes Bay and Wellington-based CEFEX certified financial planning and advisory firm.
The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
