Why lowering your risk may be risky
There is an old adage that goes, “nothing ventured, nothing gained”.
Of course, the opposite is also true: you can’t lose anything if nothing is ventured.
Let’s use someone with an extreme fear of the ocean to illustrate.
This person feels that people risk too much by playing in the waves, as there may be sharks lurking, or strong currents that could sweep them out into the open sea.
Although this person’s fears aren’t completely unjustified, it’s all about finding the middle ground between this person’s level of fear and trust.
Their fear is depriving them of the amazing experience of swimming in the ocean.
The solution to the problem isn’t that complicated – just don’t venture too deep.
By staying in shallow waters, they can still have a wonderful time, yet have enough control to reduce any form of risk if needed.
South African investors are well aware of the fact that the local investment environment was an extremely challenging one over the last four years.
Until 4 September 2018, only local bonds succeeded (and only just) in outperforming local money market (by 0.2% per year).
Local shares and SA listed properties both underperformed against money market over the same four-year period.
To make matters worse, the South African economy is now in a recession. This news, in turn, caused the rand to weaken from around R13 against the dollar to around R15.50 in the blink of an eye.
It’s only natural that local investors would want to withdraw from these highly pressurised price levels in fear of more ‘sharks’ or ‘strong currents’, and to rather look for safety in the less risky money market environment. As a client of mine recently said: “At least I’ll be able to sleep at night.”
But this too presents a problem, which is two-fold. Firstly, when we view the markets’ performance over the last 20 years, we will see that we also experienced technical economic recessions five times during this period, each of which was eventually followed by better economic growth.
Secondly, and this is the part that really bothers me, lowering your risk profile out of fear could result in you not ever reaching your investment goals.
Let’s take a closer look: According to the data supplied by a well-known retirement annuity provider, their average retirement annuity (RA) value under administration is R375 928.98 spread across more than 14 000 RAs.
Let’s assume investors ultimately aim to have an RA in place with purchasing power of R1m in today’s terms.
The table below shows how long it would take this investor to reach this goal based on different investments and taking expected annual inflation (6%) into account.
We used actual returns over the last 20 years for our calculation (understanding that past performance is not necessarily an indication of future returns).
This period includes the disappointing stock market performance of the last four years, five periods of technical economic recession, and three stock market corrections.
It would have taken them about 14 years to reach their goal, had they invested the starting capital amount into the SA Multi Asset High sector, which offers a diversified portfolio of assets, including shares.
Despite all the upheavals mentioned over the period, they would have reached their goal two years earlier, had they invested in the general equity sector. But they would have had to endure quite a bit more risk/volatility.
SOURCE: PSG Wealth Old Oak
The most interesting thing is, however, that if the average RA investor had switched their portfolio to money market 20 years ago, it would have taken them 41 years to grow their portfolio to meet the goal. That’s right, 41 years!Source: PSG Wealth Old Oak
Given current market conditions, it’s perfectly normal for investors to feel like they have to run out of the proverbial ocean as fast as they can, and to rather seek refuge on the money market beach.
But the money market isn’t necessarily the safest option for all investors, especially for those who have to reach specific investment goals within a specified period.
If you feel that the tension is getting to you, please discuss your fears with your financial adviser to help you find the well-balanced middle ground between risk and growth, so you can get a good night’s sleep.