an investor’s biggest challenge Bennie van Wyk Investment risk is one of the most difficult concepts for average investors to grasp.
The relationship with investment returns is understood vaguely – the higher the risk, the higher the potential return. But if the risk turns out to be only too real, the adviser is in the firing line. It is vital that the subject of investment risk receives close attention from investment marketers and the public. Investment risk is the probability of earning a return less than the expected return. The greater the probability of a low return, the higher the risk. Obviously, no one puts money into an investment because a loss is probable . This is the risk taken in order to participate in an investment that simultaneously holds out a prospect of good returns.
A client should have in mind a minimum acceptable return that is to be earned. Some sort of benchmark must therefore be set to enable investors and planners to gauge the acceptability of an investment’s performance.
A few definitions will help crystallise this process. The minimum acceptable return is the lowest return an investor must earn to meet the investment objective. A benchmark is an index used for comparative purposes and is usually representative of the category of securities into which the investor has decided to put his money. For example, if an investor’s objective is long-term capital appreciation, he might decide on a mix of equities. An appropriate benchmark might then be the All Share Index. To achieve zero risk, a planner might construct the portfolio to exactly replicate the structure of the Johannesburg Stock Exchange All Share Index. If your portfolio looks exactly like your benchmark, the risk of under-performing is zero. But remember, you can take “zero risk” and still lose. If the benchmark performs poorly, you perform poorly. A risk-taking investor, however, takes measured risks to outperform a benchmark and thereby achieve aboveaverage returns. Stock market returns are volatile over the short-term and can be negative. In the case of short-term losses, there is no need for long-term investors or aggressive investors to panic. Stock markets on a long-term, after-tax basis are the place to be. Bennie van Wyk is a research analyst with Momentum Advisory Services