This article originally published in The Northern Daily Leader on 15 February 2014.
One of the simplest concepts in investing is that of the trade-off between risk and return. Most people understand the notion that you may have to take on a bit more risk if you want your potential return to be that bit higher too. And it’s not just in the investment world where this concept applies. In golf or cricket for example, you might try and go for a slightly riskier shot, perhaps over some water or in the air, in order to get a slightly higher reward – closer to the pin or over the boundary rope perhaps. As the concept of risk and return is so commonplace, it’s not necessary to explain the concept in any great detail to clients. Everybody gets it almost immediately.
A more important aspect of risk and return relates to the timing. That is, when do you choose to increase your risk, or when do you choose to reduce your risk, whether it’s the risk of landing in the rough or getting caught on the boundary or just aiming for the middle of the fairway or hoping for just a single run off the over (to continue my golf and cricketing analogy). The dilemma facing investors is much the same – when should you be taking on more risk, or when should you be selling your riskier investments and seeking safety in term deposits and bank accounts? Unfortunately for investors, it’s probably harder to judge the appropriate level of risk than the task facing your average weekend golfer or cricketer.
As part of my nearly completed Master’s thesis, I have been researching the investment decision-making of trustees of Self-Managed Superannuation Funds (SMSFs). Apart from a lot of complicated detail that’s too lengthy (and probably too boring) to discuss here, I have uncovered some strange patterns in the investment decisions of SMSF trustees. One of the most interesting is that SMSF trustees in general acted to reduce their level of investment risk AFTER the recent global financial crisis, not before. Much like closing the barn door well and truly after the horse has bolted, there’s little to be gained by selling all your shares and putting the money into a bank account after the stock market has fallen by 30% – at that stage you should really be doing the reverse; cleaning out your bank accounts and buying every good quality company you can get your hands on. Of course, this is exactly when the newspapers, magazines and nightly news broadcasts are full of doom and gloom, so adopting the contrarian approach is harder than it seems. With investment risk, much as with cricketers and golfers, timing is everything.