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Which horse are you betting on?

Which horse are you betting on?

If you want to stay ahead, you need to understand your own unique risk profile

By Cassie Carstens

30 Nov 2019

Have you ever noticed, while sitting in traffic, how many kinds and colours of cars are around you? The purchase of each and every one of those cars is the outcome of a unique decision-making process of different individuals after months of research (or perhaps the result of a spur of the moment decision). The variety of vehicles is a simple representation of the spectrum of different preferences and personalities of people.

If different people cannot even unanimously decide on 1 suitable vehicle, how can they be expected to agree about where to invest? This explains why there are so many different types of investments.

Investors often ask: “What is the risk that I am taking?”

It’s only once we delve a little deeper that we realise how the concept of risk is misinterpreted.

The saying “you will reap what you sow” can be applied to the return that you can expect from the investment choices that you make. All investments can be found somewhere on the spectrum between conservative and aggressive, and the idea is to place investors on this imaginary line to be able to choose a suitable investment.

To be able to do so, a risk profile, with 10 or 20 questions, is generally used to determine an investor’s risk tolerance, but the result thereof can hardly be seen as the be all and end all. The result is largely dependent on the investor’s current state of mind or recent experience with investments. Just as a blood test is not the only deciding factor for medical treatment, an investor’s risk profile is also just one aspect that should be taken into consideration.

Sometimes a conservative investment can be risky, simply because the investor is not taking enough risk to be able to achieve his required return.

Consider these risks

There are 2 kinds of risks that you need to keep in mind regarding your investments.

  • The risk of permanent loss of capital
  • The risk of not generating enough returns to reach your goals.

The first is relatively easy to overcome by investing in regulated instruments and/or funds that are well-diversified.

The second aspect is more difficult to overcome since it depends on how comfortable you are with volatility. Many people can simply not deal with it, even though they try to convince you otherwise.

The following questions are helpful when you want to manage your risk and expectations:

  • What is your goal with your investments and what return would you need to earn to meet those goals?
  • How much time do you have to achieve the above?
  • What does your debt profile look like, and what would be the impact if investments need to be liquidised on short notice to be applied for this purpose?
  • Are you capable of dealing with downturns in your investment emotionally, or are you prone to making spur of the moment changes when things are getting uncomfortable?
  • Is your portfolio structured to be dependent on one outcome only (the weakening of the rand for example), or can it withstand multiple outcomes?
  • Are you self-critical about your own preconceived ideas?

Nobody enjoys volatility, but it is unfortunately part of any investment-ride. Market returns were disappointing the last 3 to 4 years (to say the least). In times like these, investors who thought of themselves as long-term investors, suddenly think short-term, like conservative investors.

Volatility should however be expected and should not be a reason to change your strategy (or risk-appetite).

Will you be able to keep calm?

The graph below illustrates that an investment in Apple shares would have increased more than hundredfold in 34 years. Even if you had perfect vision in 1983 of how well the shares would do over time, you still would have experienced many sleepless nights along the journey. I am pretty sure many investors would have caved under the pressure.

As wealth managers our toughest task is to get investors to take enough risk to reach their long-term goals and to ensure that they remain invested during volatile times.

The below tables illustrate the expected return profile of 2 investors.

Investor A invests for 20 or more years. His portfolio is composed of 50% South-African equity and 50% offshore equity. It has a target return of CPI + 7%.

Investor B has a 3-year investment goal and constructs his portfolio with 90% cash/bonds and 10% equity. The portfolio’s target return is CPI + 2.5%.

There is a 29% chance that Investor A’s portfolio performs worse than inflation after 1 year, but given his time-horizon and goal, this should not be a problem.

Investor B is much more concerned about the possibility of negative returns given his goal. But his asset allocation is suitable for his needs and the probability of this happening remains very small.

Your unique portfolio constructed based on your own goals, will have a distinctive probability of returns.

In the example, the investors will know beforehand which “ride” they are signing up for and what return to expect and will hopefully not deviate from the plan.

It is important to accept that your unique risk profile may change with time as you may change jobs, get married, buy a home, start a family, retire etc.

Your portfolio should at all times be compiled with your current risk profile in mind. As an investor, you are one of many on a journey to different goals. Make sure that you are one of those who does reach the winning post.

Cassie Carstens is a certified financial planner at ProVérte Wealth & Risk Management. Contact him at info@proverte.co.za.

Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.

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