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When building a financial plan, it is important for investors (that's you by the way) to consider the return required to achieve specific investment goals.
These goals are however seldom achieved without a certain amount of investment ‘risk’, and risk must therefore be considered as a crucial element when developing and implementing a financial plan.
This is according to Martin Poole, Institutional Asset Consultant at Acsis, who says that when mapping out a return vs. risk path for investments, there are hidden or less obvious risks, such as saving too little or changing time horizons, as well as constraints, such as tax, legal and regulation limit requirements, which should all be considered.
But don't fret. By understanding the possible risks and the fact that outcomes could vary greatly, you're likely to be better informed of the probability of being affected by these risks, as well as how to manage such risks.
When investors are faced with uncertainty, coupled with a lack of understanding, individuals often look for ‘solutions’ which they believe will minimise risk. “Investors sometimes focus on ever-narrowing lists, charts, comparisons and data until they are convinced that they have the lowest-risk and highest-return product or vehicle that we can possibly buy, hopefully at the correct fee.”
He says that decades of quantitative-focused information has led to this type of rationale and can therefore not be undone easily. “Effective education and a change in mind-set are required, especially at school level, but for now, I suggest focusing on the key risks that are worth worrying about.”
So, here are the key risks which investors need to be aware of:
Not saving enough - which includes preservation and consumer indebtedness
This is a common pitfall. If it takes someone with an incentive to sell a product to convince an investor to save, they are clearly unaware of a very significant risk. Not saving enough will have severe implications and consequences later in life, and is probably the most significant risk of all. Nothing protects investors from market risk quite like having more money put aside for a rainy day.
Not taking responsibility
While we all can’t be expected to be financial experts, it is the investor’s responsibility to ensure a financially secure future for themselves and dependents. While financial professionals cannot abrogate their responsibility to act in utmost good faith, investors too cannot abrogate their responsibility to invest, or save a minimum amount. This is a clear and present risk in the financial services industry.
The current bias towards intelligence over wisdom
Intelligence in this example means data and to a certain degree, abstract logic, as evidenced by young professionals with data-heavy qualifications taking greater responsibility in investment teams, while wisdom refers to prudent behaviours and robust processes, adjusted in response to experience over time.
For example, a wise person will generally not step carelessly into a river just because the last 10 rivers he crossed were shallow. An intelligent person might rationally ask why you would expect this river to be any different to the other rivers, or might even have data on the last 10 rivers, charting the probability of its depth based on prior measurements.
Gathering and analysing quantifiable information creates a risk of its own, as it may detract focus from risks that cannot be measured. Reliance on data and intelligence only is therefore risky, and combining wisdom with intelligence should help reduce the risk of devastation of wealth through one catastrophe.
Regulatory risks to asset allocation
Industry regulation places limits on asset allocation for asset classes, such as 75% in equities or 25% offshore, and these regulations are put in place to limit concentration risk, and possibly reduce the outflow of savings capital from South Africa. However, it also limits the full and free expression of investors’ financial opinion, and places a limit on the return they can expect to achieve with pension savings.
This is a type of unintentional risk, but one worth worrying about as the complexity of these limits increase the costs associated with compliance and administration.
Conflicts of interest and governance failures
In the investment industry, conflicts of interest and governance failures are widely known, but rarely discussed, and this increases risk as it compromises independence and objectivity in the industry.
There is an asymmetrical payoff for managers in that they receive a basic salary, as well as a large bonus if the share price does ‘well’, but seldom have to pay back remuneration when things go ‘badly’. The risks posed by these asymmetrical payoffs are real for investors, and definitely worth worrying about. These risks can only be mitigated by forcing managers to have a direct interest in their investors’ outcomes over long periods of time, including enforcing negative pay.
These goals are however seldom achieved without a certain amount of investment ‘risk’, and risk must therefore be considered as a crucial element when developing and implementing a financial plan.
This is according to Martin Poole, Institutional Asset Consultant at Acsis, who says that when mapping out a return vs. risk path for investments, there are hidden or less obvious risks, such as saving too little or changing time horizons, as well as constraints, such as tax, legal and regulation limit requirements, which should all be considered.
But don't fret. By understanding the possible risks and the fact that outcomes could vary greatly, you're likely to be better informed of the probability of being affected by these risks, as well as how to manage such risks.
When investors are faced with uncertainty, coupled with a lack of understanding, individuals often look for ‘solutions’ which they believe will minimise risk. “Investors sometimes focus on ever-narrowing lists, charts, comparisons and data until they are convinced that they have the lowest-risk and highest-return product or vehicle that we can possibly buy, hopefully at the correct fee.”
He says that decades of quantitative-focused information has led to this type of rationale and can therefore not be undone easily. “Effective education and a change in mind-set are required, especially at school level, but for now, I suggest focusing on the key risks that are worth worrying about.”
So, here are the key risks which investors need to be aware of:
Not saving enough - which includes preservation and consumer indebtedness
This is a common pitfall. If it takes someone with an incentive to sell a product to convince an investor to save, they are clearly unaware of a very significant risk. Not saving enough will have severe implications and consequences later in life, and is probably the most significant risk of all. Nothing protects investors from market risk quite like having more money put aside for a rainy day.
Not taking responsibility
While we all can’t be expected to be financial experts, it is the investor’s responsibility to ensure a financially secure future for themselves and dependents. While financial professionals cannot abrogate their responsibility to act in utmost good faith, investors too cannot abrogate their responsibility to invest, or save a minimum amount. This is a clear and present risk in the financial services industry.
The current bias towards intelligence over wisdom
Intelligence in this example means data and to a certain degree, abstract logic, as evidenced by young professionals with data-heavy qualifications taking greater responsibility in investment teams, while wisdom refers to prudent behaviours and robust processes, adjusted in response to experience over time.
For example, a wise person will generally not step carelessly into a river just because the last 10 rivers he crossed were shallow. An intelligent person might rationally ask why you would expect this river to be any different to the other rivers, or might even have data on the last 10 rivers, charting the probability of its depth based on prior measurements.
Gathering and analysing quantifiable information creates a risk of its own, as it may detract focus from risks that cannot be measured. Reliance on data and intelligence only is therefore risky, and combining wisdom with intelligence should help reduce the risk of devastation of wealth through one catastrophe.
Regulatory risks to asset allocation
Industry regulation places limits on asset allocation for asset classes, such as 75% in equities or 25% offshore, and these regulations are put in place to limit concentration risk, and possibly reduce the outflow of savings capital from South Africa. However, it also limits the full and free expression of investors’ financial opinion, and places a limit on the return they can expect to achieve with pension savings.
This is a type of unintentional risk, but one worth worrying about as the complexity of these limits increase the costs associated with compliance and administration.
Conflicts of interest and governance failures
In the investment industry, conflicts of interest and governance failures are widely known, but rarely discussed, and this increases risk as it compromises independence and objectivity in the industry.
There is an asymmetrical payoff for managers in that they receive a basic salary, as well as a large bonus if the share price does ‘well’, but seldom have to pay back remuneration when things go ‘badly’. The risks posed by these asymmetrical payoffs are real for investors, and definitely worth worrying about. These risks can only be mitigated by forcing managers to have a direct interest in their investors’ outcomes over long periods of time, including enforcing negative pay.
