Beware losing money, but risks equal return
Returns are important but must always be judged by how much risk is involved, Martin Hawes writes.
At 11pm on November 9, members of the Summer KiwiSaver Investment Committee discussed our asset allocation.
I chair this committee and Trump had just been elected - a whole new investment environment with new opportunities and new risks had been dropped on us. We decided meet formally the next day.
We thought that Trump would cut taxes and that interest rates would increase. So we decided to reduce our holding of bonds (fixed interest investments) and to map out a game-plan to increase our holding of international shares.
That turned out to be a pretty good call.
It is important to note that we took two steps – one a buy and the other a sell. The motivation of each of these actions was different: the sale of bonds was about risk reduction as bonds would probably fall in value. On the other hand, the purchase of the international shares was to enhance returns – buying into this asset class was about making money.
If I am managing your money and you want higher returns, I can get them for you very easily by simply taking on more risk. I get your higher returns from greater risk, but remember, it is your money,not mine that is in jeopardy.
Higher returns will make me look very good. The returns I get for you will be applauded, but the cheers won’t last. At some point, the high returns will come with volatility and during the downturns, investors are likely to get fairly grumpy.
Returns are clearly important, but they must always be judged by the amount of risk that is taken to get them. Following Trump’s election, we were certainly looking for opportunity but, equally, we cared about vulnerable investments.
Investors always need to think about risk adjusted returns. When someone is telling us about the great returns that they have, we need to ask how those returns were achieved. Sometimes they have indeed come from the application of skill – but sometimes they simply come from greater risk.
Warren Buffett said there are two rules for investment: to not lose money and to never forget rule number one! The greatest investor in the world cares as much about risk as he does about returns. Your first return should be the return of your money.
Buffett knows it is difficult for an investor to come back from a significant loss. You have to get a lot of investment return. Buffett manages risk by only investing in things that he knows well after doing a lot of homework.
Risk and return go together – they live in the same house. .
Martin Hawes is the Chair of the Summer KiwiSaver Investment Committee. The Summer KiwiSaver Scheme is managed by Forsyth Barr Investment Management Ltd. You can obtain the Scheme’s product disclosure statement and further information about the Scheme on our website at www.summer.co.nz. Martin is an Authorised Financial Adviser and a Disclosure Statements is available from Martin Hawes on request and free of charge.