Those of us who work in financial services are often accused of talking jargon and rightly so! Some even do it to impress clients with all the terminology they use (does this even work?!). Most of us just slip into it as we use it every day and forget at times that we can be talking to people who have never heard of these terms, never mind understand them. A very important term I use when talking to clients about their money is investment risk.
What does investment risk mean to you?
When talking to clients, I don’t like to assume that they have the same understanding of finance as I do (A client told me he was a conservative investor and had all his money in the S&P 500. That’s as high risk as I get!). So I always ask clients what their investment risk means to them. Everyone gives me the same answer, losing all their money.
Can you lose all your money?
There are a few situations where you have an increased risk of losing your money:
Borrowing to invest – If you borrow to invest, you have to service the debt with the investment, usually property, as security. If the value of the property falls below the value of the debt, you are in negative equity. If you are not servicing the loan, the lender can recall the debt and you end up with nothing.
Fixed Term Investments – Some investments mature at a fixed date in the future. This means that market timing forms part of your investment strategy i.e. you are hoping that the markets are doing well when the term is up. If markets are down and the investment matures, you do not have any time to make your money back. But even in these scenarios, it is unlikely you will lose all of your money.
Fraud – Quite simply, someone may rob your money.
Unnecessary risk – You or the fund manager may have taken an unnecessary level of risk with the investment. An easy illustration for this is payday loans. The interest rate on these can be 180% and more. Why? There is a good chance the lender won’t get their money back. Same with investing in start up companies or junk bonds. There is a high expected return from these because there is a good chance you won’t get your money back, so don’t be fooled by the high expected return, there’s a reason for it!
So what is investment risk?
Investopedia defines risk as:
Risk involves the chance an investment‘s actual return will differ from the expected return. Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment.
Or as a client once said “how much your fund goes up and down”.
If you invest in a basket of good quality companies and government & corporate bonds (remember burn the bondholders? It never happened). When there is a market crash, the share price will fall and so will the value of your stock. But does that mean people have stopped eating Domino’s pizza or buying toothpaste? A lot of the companies that you will have invested in have been around for decades and are multi-billion dollar companies. They are well run and have been through it all before.
You can reduce the level of ups and downs that your portfolio has by investing some of it in cash or short term bonds. The more in these “defensive assets”, the less volatility in your portfolio and the you can expect your money to grow by less in the long term.
So keep your investments open ended and invest in good, solid companies and the worse case scenario will be that you have to hold your investment for longer than you originally intended to.
If you have any questions, you can email me directly at [email protected]
11 December 2017