Why getting your attitude to investment risk right really matters

May 21, 2020 | Tony Byrne's View

Most clients are aware that we review their attitude to investment risk when conducting annual reviews and whenever there are important changes especially when they invest money or withdraw it from their portfolios.

I’ve always felt that the word risk conjures up the wrong image – one of permanent loss of money which research has shown is akin to the fear of death for many investors. The following graph quite rightly shows that the level of risk is really a measure of the volatility of your portfolio rather than the risk of loss. Remember you only lose money when you sell.

The graph shows the past performance of the Parmenion Strategic Passive portfolio over the ten year period from October 2009 to October 2019. The strategy invests in 12-15 separate funds. Each fund typically invests in 40-50 shares which means there is a huge diversification of risk for the investor who is indirectly invested in approximately 600 shares.

You will see that there are 10 different coloured lines on the graph. Each line represents a level of risk from 1, the lowest, in blue, to 10 the highest, in brown. Not surprisingly the lower the level of risk, the lower the return, but also the lower the volatility, or zig and zag, of the investment. The higher the level of risk, the higher the return and the higher the volatility. Over the 10 year period covered there was only one risk grade which didn’t produce a higher return than the next lowest grade and that was risk grade 9 which was slightly edged out by risk grade 8.

So what is the difference between risk grades 1 and 10?

In all risk grades there is a mixture of shares, property, bonds and cash. These are known as the four main asset classes of what is described as asset allocation or diversification of risk. In other words not having all of your eggs in one basket. At the lower risk grade levels there is proportionately less money invested in shares and more in the other three asset classes. At the higher levels of risk there is a higher proportion invested in shares and less in cash, bonds and property.

So why is this so important?

Well it is because it demonstrates that over longer periods of 10 years or more equities (shares) outperform cash, property and bonds more than 90% of the time. Over even longer periods the outperformance is even greater and closer to 100%. In fact over longer periods of 20, 50 or 100 years, US equities, as measured by the S&P 500 Index, for example, have produced average investment returns of 6.7% a year including dividends re-invested over all three time periods. The consistency of investment returns from investing in equities is quite extraordinary.

As most people naturally perceive risk to be the potential loss of money they tend to class themselves as medium risk investors. Over 90% of our clients are risk grades 4-6. Also most husbands have a risk grade one level higher than their wives. As the majority of our clients have an investment time horizon of at least 10 years, in my considered opinion, they should be invested primarily in equities because this asset class not only produces the best investment returns but also an income, in the form of dividends which consistently beats inflation too.

Admittedly this does mean that investors will experience more ups and downs, more volatility, with their investments but in the long run, far greater returns if history is anything to go by.

I have been encouraging clients to increase their attitude to investment risk in their annual review meetings for some time now and most clients have agreed to do so. I found it particularly interesting that at risk grade 4 the 10 year return was 84.11% but at risk grade 6 it was 121.76%. So by simply changing one’s risk grade from 4 to 6 an extra return of 45% was achieved. That is a not insignificant extra return. In monetary terms it is the equivalent of investing £100,000 and making a gain of £84,110 instead of £121,760. And what was the price to pay? A little more volatility. Surely it is worth it, isn’t it?

Remember the risk of investing in shares is where you put all of your eggs in one basket or maybe just a few baskets by investing directly into just one or a handful of shares. You could potentially lose all of your money. What’s more there is no investor compensation scheme protection for direct investment into equities either.

If, on the other hand, you invest in an investment such as the Parmenion Strategic Passive Strategy you are invested indirectly into about 600 shares and your investment is protected by the Investor Compensation Scheme which protects up to £85,000 of your investment per fund management group. So assuming you are invested in, say, 15 funds from 15 separate fund management groups via the Parmenion Strategic Passive Strategy, you have investor protection of £1,275,000 (15 x £85,000. If you invest jointly as husband and wife you have twice the limit of £2,550,000.

Should you increase your attitude to investment risk now?

In my opinion, for the majority of clients, I would advise an increase in their attitude to investment risk, especially bearing in mind that there has been a recent stock market crash and there is a likelihood of a further sharp fall over the next few months. That means they will be able to buy shares very cheaply. However, it is best to at least discuss it with me first just to ensure it is appropriate for you based on your personal individual circumstances.

Another way you could potentially benefit from the eventual and inevitable rebound in share prices once they have bottomed out, is to invest a higher proportion of your Parmenion investments into our sister company, Minerva Money Management’s, CCM Intelligent Wealth Fund. This is a 100% equities fund which has a very exciting future. You should be aware that currently the fund has a lot of money in cash and gold ETFs as a hedge against a further stock market correction which is highly likely in my opinion, and many stock market commentators and renowned guru investors, such as Warren Buffett. We will use these funds to re-invest into equities at substantially reduced prices when that happens. Again discuss it with me first before you make your decision.

At the time of writing, on 8 May, it is Bank Holiday Friday, the 75th anniversary of VE Day. Although we are not at war it certainly feels like we are facing war-like conditions. Hopefully Boris Johnson will have introduced a relaxation of the lockdown rules by the time you read this blog.

Enjoy your gradual return to the “new normal” whatever that may be. Do consider increasing your attitude to investment risk and either increasing your investment in our fund or putting money into it for the first time. You know it makes sense.

*This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs’ practice. Levels and bases of tax relief are subject to change.

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