• A different perspective of risk
His parents have been warning of the risk in investing, “Sam, we have lost all our hard earned money in the share market. The safest place is to keep all your money in the bank account.”
Are bank savings truly riskfree?
The answer is “no”. Even if savings or deposit accounts lack the volatility risk, they are not safe from the often overlooked and underestimated threat of inflationary risk.
Notice how we differentiate the word, ‘risk’ into several distinctions – volatility and inflationary? What is risk?
To think that risk represents the potential downside of an investment would be merely scratching at the surface. We have to look at risk from a broader perspective.
Risk can be defined as the possibility of not achieving an objective. So the next relevant question to ask is; what then, is your ‘objective’?
If Sam’s aim is to achieve financial freedom by the age of 40 with a normal-paying nine-to-five job without an interest in starting his own business, a remote possibility of receiving an inheritance while merely putting all his hard-earned money in the bank savings – he risks achieving that goal.
In the investment and finance context, risk will always be an ever-present component. What we need is a proper understanding of the various types of risk and managing those risks. There is a broad range of risks but we will try to list a few of the more commonly known ones here. Market risk
That means that a fall in the broader capital or financial market whether on a local or global scale could negatively affect the value of investment.
In layman terms, if property prices fall in the nation, that beautifully-maintained house in a prime location will inevitable fall in price as well. Much like how a fundamentally strong stock would in a market downtrend. For wise investors, however, a downtrend is their cue to buy. Liquidity risk
It refers to the ease of liquidating or selling an asset. If that particular investment is illiquid, it may take a while to sell the investment or to receive money from that sale. Besides that, you may also be forced to sell at an unfavourable price. Inflation risk
It is the risk that the investment returns may not keep pace with inflation. If the inflation rate is running at five per cent per annum while the returns on your investment is only generating three per cent, it means that your capital is being gradually eroded. Your cost of living will increase as your purchasing power becomes reduced. Does high risk mean high returns?
Generally, in order to achieve higher returns, we have to be prepared to take on higher risks. Take an example of the risk/return relationship from the stock market and a savings account.
Due to the higher risks (price fluctuations, market risks and others) that he assumes by investing in the stock market, an investor would be well compensated for the risk he is taking (possibility of returns of more than 10 per cent per annum).
On the other hand, by placing his money in a bank account, the investor can be certain that the returns that were promised is certain and predictable without being affected by price volatility or market risks.
The lower returns commensurate the lower risks.
But before we conclude that high risk equals high returns and low risk equals low returns, let us look at a common life goal:
Notice how everyone wishes that they are a millionaire? If that is still your aim of making your first million within 10 years, well, we’ve got bad news for you.
In 2028, in present value terms and headline inflation running at five per cent, that RM1 million will only be worth RM613,913 today. You will still be a millionaire, but look how much your purchasing power has eroded.
In this regard, we hope you have input an appropriate rate of inflation into your retirement calculation.
Underestimating the effects of inflation can lead to a faster-thanexpected rate of capital attrition. The inflationary effect become even more pronounced over time and accelerates as inflation climbs.
Some retirees may put their entire nest of eggs into a savings account for its ‘safe’ features. In the face of high inflation, however, that low risk, low return vehicle may turn out to be low return but high risk instead.
Equities have historically been proven to be a good hedge against inflation. If you are still young, and your investment horizon is long, your investment has enough time to recover from any market downturns. Invest consistently, even when markets are down.
For retirees, do not shun away from equity risk either. Even a 10 to 20 per cent allocation in equities can help to boost your retirement portfolio and help generate returns which are at least in line or above the inflation rate.
Building wealth over time or even to sustain your purchasing power requires some form of risk-taking.
This can be a calculated move to take on more risks: Start with the end goal of your investing in mind and work towards optimising your portfolio returns.
We hope this issue has changed your perspective on risk.
Areca Capital is a niche Malaysian fund management and wealth advisory/financial planning company.
We are a firm believer in the advisory-based approach towards investing.
We help our clients, who range from individuals to corporates, family and private trusts, foundations and other institution to achieve consistent risk-adjusted returns over the long term.
For any enquiries, you may contact us at 03-79563111 or by email: invest@arecacapital.com.
Disclaimer: The article is produced based on material and information compiled from reliable sources at the time of writing. The article is not an offer, recommendation or advice to transact in any investment products, including the stocks or funds mentioned within. Investors are advised to consult professional investment advisers before making any investment decision.