Tag Archives | investment risk

The Impact of Fear

FearThe Impact of Fear

The impact of the turmoil in Greece on share markets is a classic example of how the emotions of fear and greed create volatility. When shares start to drop in value, investors can become fearful of sustaining further losses. This leads to panic selling which further fuels the fear. Eventually a turning point is reached where less risk averse investors spot the potential for gain. Increased buying activity pushes prices up, and fear is allayed. The outcome of this process is that risk averse investors suffer losses while gains go to those who are less risk averse.

Significant events can have a ripple effect on markets, just like a pebble being thrown into water. High levels of uncertainty create high volatility, and as the outcome becomes clearer, the uncertainty and volatility gradually decrease. Volatility is a test of true levels of risk aversion. It is easy to be a confident investor with a high exposure to growth assets when volatility is low and returns are high. Falling prices quickly reveal attitudes to risk. They also reveal insecurities formed from previous episodes of volatility. Memories of events such as the Global Financial Crisis can create irrational fear.

Diversification is one of the principal tools for reducing risk. The risk of investing in a portfolio with an adequate level of diversification is not a risk of loss but a time risk – that is, how long the investor has to remain invested in order for value to be restored and for the investor to be rewarded with a rate of return over the investment period which reflects the degree of risk taken. Volatility is a reminder that investment in growth assets is a long term game. If long term goals and strategies have not altered, short term volatility should be of little concern.

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Speculator or Investor?

Speculator or Investor?

It is very tempting when you have a small amount of money to invest to try and turn it into a much bigger amount by taking a chance on risky investments. With luck on your side, and careful research, it is possible to double your money, but only by accepting the possibility that an alternative outcome may be a significant loss. Seeking extraordinary returns on money invested through accepting high levels of risk is speculation.

Speculators rely on sudden changes in financial markets caused by such factors as changes in economic conditions, regulation, consumer tastes, technology etc to make windfall gains. In essence, speculators are gamblers. They work on the assumption that they can predict investment returns more accurately than other investors.  Making money successfully from speculation usually requires extensive research, time spent monitoring the performance of investments and reviewing investment decisions, a strong, analytical approach to decision making that is devoid of emotions such as fear and greed, and the courage to either proceed or back away quickly when it is appropriate to do so.

An investor is someone who invests money in financial assets with the aim of making a profit. Speculators are investors, but not all investors are speculators. An investor who is not a speculator is someone who takes a medium to long term view of investment returns, being prepared along the way to accept short term changes in investment conditions. Investors adopt a more passive approach to investing. Whereas speculators are driven almost exclusively by return, investors find a balance between risk and return they feel comfortable with. A combination of speculating and investing can work well. Invest the bulk of your funds, and speculate with a small amount you can afford to lose, in the hope that you might just strike the jackpot!

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The Biggest Investment Risk

Risks for Retired Investors

Retired investors typically look for security in their investments ahead of return. Superannuation payments barely cover the cost of living from day to day and saving in retirement is not possible without a frugal lifestyle. This means that any loss of capital from failed investments cannot be recouped from income.

Some retired investors fail to realise however, that loss of capital doesn’t only arise from failed investments. An investor with $100,000 in bank deposits, who uses the interest to supplement income, stands to lose over 20% of his or her capital over the next ten years just by leaving it in the bank. Let me explain why.

A ‘basket of goods’ that cost $100 in December, 2000 would today cost around $131. If we project that same average rate of inflation forward, $100,000 in the bank today will only buy the equivalent of around $77,000 worth of goods in ten years time. That is a loss of around $23,000 over the ten years. Not only that, the income from the investment will fall in value. If, for example, interest rates are 6% on average over the next ten years, the income from $100,000 would be $5,370 per annum after tax at a10.5% rate. In ten years time, however, that income will only buy around $4,130 worth of goods in today’s terms. A retired investor who invests for income and uses all that income every year will therefore suffer a significant loss of both capital and income over the long term. Given that many people spend twenty or even thirty years in retirement, the potential loss of capital and income is huge.

How can this be avoided? Investing a small part of your retirement nest egg in a diversified portfolio of growth assets will help prevent losses from inflation and tax.

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