Risky business

Jun 4, 2020 | Investment, Reflection

We’ve all known someone like this child. Maybe it was you!

The kid from your childhood who was always going further, higher or faster than anyone else. No dare refused. Nothing too dangerous. The risk taker.

Those kids were fun to hang around. They made life exciting.

But is there any space for risk taking in the sensible and responsible world of financial planning?

The short answer is, surprisingly, ‘Yes’.

When it comes to investing for your future, the more risk you take on the more return you can get in long term. And that’s a good thing. However, more risk means a bumpier ride.

Recent events provide a good illustration of the risk effect. The following chart shows how an investment across different portfolios performed for the 12 months before COVID-19.

The coloured lines show the returns for a range of diversified portfolios (from Conservative to High Growth, managed by Vanguard) with a starting balance of $10,000. The exposure to growth assets varies from 30% for Conservative through to 90% for the High growth fund.

With markets for that 12-month period trending up, we can see that the more risk exposure the better the return.

The next chart shows the same portfolios over the last few months with markets reacting to the consequences of COVID-19.

In this case the opposite applies. The better and smoother performance comes from the portfolio that has least exposure to growth assets.

This table below provides a nice illustration of the issue, for those who like tables.

The Conservative portfolio never got as high as the High Growth portfolio over the past year. It was more than a $1000 less. But the Conservative portfolio never dropped as low as the High Growth one either.

As things currently stand, the Conservative portfolio is doing better by about $100. And of course the difference between the high and low points was a modest $1,272 for the Conservative portfolio compared with a nerve-jangling $3,457 for the High Growth portfolio.

What does all this mean?

It means it is OK – even advisable – to take on risk to get the returns we need for our long-term financial future. That’s because the more risk we have in a portfolio the greater will be the longer term expected return. (Even though the swings in highs and lows over that time will be higher).

But we generally want a less bumpy ride the older we get. So it is good to have a plan that reduces risk as the years go by. And that’s something financial planners can help with.

When investing it can be OK to ride a skateboard down a steep slope. But if you’re going to do it, it’s good to fully appreciate the risks and it’s probably best to avoid it as you get closer to retirement!

Enjoy the week
Simon

P.S. The painting is by Australian artist Ron Francis. I had seen the picture previously but never known who painted it.

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