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There is an old saying that goes, “Nothing ventured, nothing gained.” Of course the contrary also rings true, as you cannot lose if you don’t try. Let’s imagine a person with an extreme fear of the ocean as an example. This person feels that people risk too much by playing in the waves as there may be sharks that could attack them, or strong currents that could sweep them out to sea. Although this person’s fears may be valid, it’s really about finding the middle ground.
The fact that this person isn’t willing to risk anything is depriving them of experiencing the wonders that the ocean has to offer.
The solution quite simply lies in the fact that this person does not have to play in the deeper waters like most adrenaline junkies do, but rather stay in shallow waters where they can still have a wonderful time while being in control and lowering the risk of anything going wrong.
The prices that investors have been willing to pay for shares worldwide over the past year have caused me great concern. In the same way that the ocean may be calm at times, investors started to ‘swim’ deeper and deeper into the stock market up to a point where I feel that they are no longer 100% in control of investment risk.
Suddenly the ocean has become stormy, with a number of indices losing value in August: the S&P 500 lost 1.3%, the FTSE100 2.9% and the Chinese Shanghai Index lost 10.4%.
Locally, things didn’t look any better as there was no hiding from the FTSE/JSE All Share Index losing 3.6% of its value over the same period.
With investment specialists worldwide expressing their concerns that this may only be the beginning, I don’t necessarily feel that now is the time to get out of the water completely, but rather to ensure that you still have enough control over your investment risk. Although no one may know for certain what the future holds, risk remains manageable.
For investors, investment risk is crucial, more so than how much these investments have grown over the past five years. Local unit trusts, for example, have grown by 6.24% over the past 12 months (up to 11 September, and excluding money market and specialist sector funds) despite my concerns, at an average risk (standard deviation) of 6.2% calculated annually.
This may not look too promising at first glance, especially when considering the total growth of 101% (14% a year) over the past five years, and 308% growth (14% a year) over the past 10 years. The fact remains, however, that it doesn’t look too bad when compared to the 1.5% loss in local shares and money markets’ 5.51% returns over the same 12-month period.
One way of reducing the discomfort is to focus on funds, and fund managers, who are focused on continuously lowering the risk within their funds.
This way, you will be able to enjoy the benefits of higher-risk investments without sleepless nights.
Let’s take funds with the lowest standard deviations (risk) as an example: If you had invested in only the top five funds with the lowest standard deviations (risk) in each sector, your investment return would have amounted to 6%, but an average standard deviation of only 4.99% (80% of the risk).
I suppose the historical returns on shares, property and bonds will always provide for a powerful attraction to these types of investments. I urge you to be cautious, however, because if this is only the beginning of a volatile market, you would want to ensure that you are protected against the strong currents that may carry you out to sea.
This is an excerpt of an article that originally appeared in the 1 October 2015 edition of Finweek. Buy and download the magazine here.
