Behavioural finance has an increasingly central part in conversations about investment risk, since managing emotional responses plays a key role in maximising returns.
Many DIY investors may be exposed to far more risk than they are really comfortable with, according to new research underscoring the importance of a proper assessment of investment risk and your true tolerance for it.
According to a survey by Wealth Horizon, the vast majority – 69% – of UK investors are only willing take on the risking of losing 6-11% of their initial investment in a bid to garner better returns. Yet, as the firm points out, many funds (and indeed many popular ones) have posted far greater losses in the past decade, meaning that investors who are too over-exposed to just a handful of funds might be unconsciously taking on far more risk than they think. When markets are buoyant it’s easy to pile into the next exciting investment fund, but there are lots of risks for investors to consider, and some are more obvious than others.
The spectacular losses some investment vehicles were hit by during the financial crisis will still be leaving a sour taste in the mouths of many investors, as with the invocation of controversial “gating” conditions which meant that leaving a “sinking ship” by exiting the fund was not an option – often very for very long periods of time. So, we do not have to cast our minds back far to recall just how quickly fund investments – like many others – can go sour.
And of course, funds don’t just show losses during times like the global financial crisis. There is a reason that financial journalists publish lists of “dogs” and so eagerly track the fortunes of the star fund managers as they rise (and sometimes also fall). It is inevitable in a fund universe comprising over 7,000 mutual funds, not to mention Exchange-Traded Funds and other types of collectives, that there will be winners and losers – and everything in between. It is little wonder that the ups and downs of the mutual funds sector, which globally accounts for an incredible $7.6bn of investor money, is so avidly watched.
The problem with picking investment funds is that you are not just looking for the best, most-skilled fund manager, although that clearly helps as correctly timing the markets and being able the steer the right course for a fund on a short, mid and long-term view is of course a rare talent. Rather, it is the fact that fund managers, and their funds, are at the mercy of a number of factors which are outside their control. Of course, fund managers will always be looking ahead to maximise gains and minimise risk. However, in a world where currency shocks, plummeting oil and geopolitical turmoil are still fresh in investors’ minds it would be folly not to admit the possibility a fund manager being blindsided and fund losing a lot of value (at least in the short term).
The consequences for an investor who had dedicated an overly large proportion of their wealth to a fund which experiences serious losses are clear to see. They could be worse off still if the other funds they were holding were suffering too. The point is that myriad factors affect the prospects of an investment fund and it may well be that two seemingly very different vehicles are negatively impacted by the same event or economic trend.
Diversifying your fund investments is therefore key. One of the reasons people like to invest in collective funds is that they offer diversification benefits because a wide portfolio of securities are packaged up into one easy-to-access investment. But investors need to also think about diversifying properly at the fund level too by “looking under the bonnet” of each investment and carrying out a thoroughgoing assessment of the risks it may present and how it would work within your overall portfolio. Each investment added or exited will change the risk profile of your portfolio; you must make sure this continues to be a precise match for yours, in light of your personal circumstances and needs.
Wealth Horizon found that just a quarter of UK investors are willing to up the stakes to the extent to which they could lose over 11% of their initial investment in exchange for the prospect of greater gains. Yet investors who are relying too heavily on too narrow a range of funds may be sleepwalking into having a far greater exposure to risk than they ever intended and could stand to lose far more than 11% of their initial capital. Research indicates that self-directed investors tend to hold ten or even fewer funds and so it seems that many investors could be quite far from where they want to be on the investment risk front.
If you are worried about investment risk, engaging with a professional adviser and talking over your current and future investments in light of your financial goals could be a shrewd move. Not only could a wealth manager significantly reduce your risk exposure, they could also offer far more attractive returns through a more robust investment management strategy. To start the process of finding the right adviser for your profile and financial goals, simply try our smart online tool. Or, if you would like to discuss your situation with our straight-talking team, please do get in touch here.