Investment warnings ensure we all remember that returns are our reward for taking on a degree of risk. Recent market gyrations have underscored that they are real.
It’s hard not to conclude that the real risk to investors is themselves, however. There is a growing body of research highlighting just how much investors can get in their own way, sacrificing long-term returns on the altar of short-term comfort. Emotional decision-making has been calculated to cost the average investor 3% in returns annually.
The urge to “do something” is strong at times of crisis, even if that means buying high and selling low – as evidenced by the fact that 1.4 million UK investors sold £10,000 or more of their investments during the early stages of the COVID crisis (and half a million £100,000 or more).
Many of these people will have made paper losses real by retreating from the markets. Their losses will have been compounded by the fact that six in ten of these people have subsequently let their capital languish as cash at near-zero rates. Those who held firm while the market found its bottom and then resurged have been vindicated; even more so those who took the lows as an opportunity to buy in.
Every investor experienced a wild ride. The question is how they experienced it.
Over a third of affluent investors believe the crisis exposed flaws in how they or others had understood their risk-profile, and no doubt. It’s very hard to imagine how bad things can get, and how quickly, until they do. Ask any investor to self-assess their risk-appetite in halcyon days and then in the midst of market chaos, and they may well give very different answers as to how much risk they are prepared to take on.
Capacity for loss is relatively easy to assess, but risk attitude – or appetite – is more dynamic, subjective and frankly difficult to measure. Yet new technologies are making it possible to include far broader metrics to get a true picture, and there is now far more focus on the behavioural, or financial personality, side of things.
The reasons are twofold. Firstly, it’s about results. The more an investor understands their financial personality, the less likely they are to go with an emotionally biased investment decision based on their “instinct” or other dubious internal weathervane. Forewarned, and so forearmed, they have better hopes of sticking to a long-term plan and riding out the dips that come along every decade or so. Better still is having a wealth manager well aware of how you tick who can “make” you stick to it.
Secondly, and just as important, is having emotional comfort during your investment journey. Some people see opportunity in stock market volatility, but it really costs others sleep. Risk and returns need to be balanced against your real-life comfort and actual financial needs.
Time-horizon, liquidity and purpose
Time-horizon is a big part of all this. For the millennial building up their pension pot and looking decades off, volatility needn’t mean too much, but for the imminent retiree, market shocks might force a complete revision of their plans.
Liquidity is another. Being a forced seller in a market downturn is never where you want to be, so ensure that you can always make any foreseeable calls on your cash without having to liquidate investments. Keeping at least several months’ living expenses on hand in cash is always a wise move too.
And finally, to the crux of the matter: purpose. We are all investing for a reason, right? Well actually, reasons would be more accurate and this has a huge impact on attitude to risk. They may not be formally separated out, but most investment portfolios will contain “pots” for retirement, home upgrades, new cars, private schools, university and more. For some purposes (and amounts) we may be risk on, in others very much off. They definitely have different emotional load.
This has been a year of tough lessons for investors, and the need to really understand your risk exposure – and what that might feel like – is certainly one to take away. What your investments are for, in the round, and exactly when and how you need them to come to fruition are deep questions. Is it time you reflected on risk?
This piece is for informational purposes only, and is not intended in any way as financial planning or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.