What’s the risk of not understanding risk ?

Life is risky. And we all understand that money plays a big part in many of the risks that we face as we try to get ahead in the world.

The risk of not having enough money to put the kids through school, or for a deposit on that first home is very real and easy to understand because it is relevant and the consequences are clear. You can close your eyes and easily imagine how it will affect your life – if you don’t save enough (or blow it on something else) you simply won’t achieve your goal.

However when you approach financial markets, the concept of risk quickly morphs into obscure terms like tracking error, sharpe ratio, and ex-ante volatility. Risk is often presented in terms that serve the investment products on offer, rather than relating to the investors real life risks.

The problem of addressing true investor risk has partly been addressed by the emergence of ‘outcome-oriented investments’. This approach differs from traditional investments that aim to beat a particular benchmark – something that is not appealing in the event of a crash.

Instead, outcome-oriented investments seek to preserve capital, and to achieve a particular return above inflation – an objective that aligns better with most investors personal goals. By doing so, these funds do not chase returns if markets are overheated and the risk of capital loss is too high.

Achieving these objectives is easy in some market conditions, and very difficult in others. Such strategies require significant flexibility in how they invest, and are often referred to as having a ‘dynamic’ asset allocation.

The uncomfortable trade-off for investors is allowing the investment manager greater freedom in how to invest their money, and recognising that some risks are just not worth taking. For example, when markets are running hot, funds that aim to preserve capital will miss out on these higher returns – in order to avoid the potential collapse.

To use a motoring analogy, investors may choose to not bother themselves with the intricacies of all moving parts of an engine, however they should know their destination along with how fast their vehicle is willing to go. They would like to get to the destination as fast as possible, but also to ensure they arrive safely. Insight into these things helps us understand the likelihood of an accident or being late and whether to get into the car at all. The very same considerations should be applied to any investment strategy and checked regularly.

Keeping all investor conversations about risk relevant and real is crucial for the wealth industry. Please contact us on 08 8232 9498 as every discussion should somehow tie back to the approach (i.e the risks worth taking) and the progress (i.e returns earned) on the journey towards a specific wealth goal.

 Reference: Nab assetmanagement 19 April 2018 

Important information

This  publication is provided by MLC Investments Limited (ABN 30 002 641 661, AFSL 230705) (“MLC”), a member of the group of companies comprised National Australia Bank Limited (ABN 12 004 044 937, AFSL 230686), its related companies, associated entities and any officer, employee, agent, adviser or contractor therefore (“NAB Group”). An investment with MLC does not represent a deposit or liability of, and is not guaranteed by, NAB or any other member of the NAB Group.This information may constitute general advice. It has been prepared without taking account of your objectives, financial situation or needs and because of that you should, before acting on the advice, consider the appropriateness of the advice having regard to your personal objectives, financial situation and needs.

Opinions constitute the judgement of MLC at the time of issue and are subject to change. MLC believes that the information contained in this article is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made at the time of compilation. However, neither MLC nor any other member of the NAB Group, nor their employees or directors give any warranty as to their accuracy or reliability (which may change without notice) or other information contained in this article. This information is directed to and prepared for Australian residents only.