Discover where your investments fall on the risk spectrum and learn how to manage investment risks effectively for better returns. File photo.
If you ask an investment expert to define investment risk, he or she is likely to say: “The probability of your investment not performing as expected”. To me, that is a bit lame. If an investment performs slightly lower than the average return of investments in the same category, I won’t be too concerned. I am much more concerned about the probability of losing part or all of my capital.
We all have some idea of differences in risk among investment types. We know that bank deposits, for example, have a minimal degree of risk. On the other hand, shares in a company can be relatively risky.
The investment risk spectrum
If you ranked the various types of investments (and “so-called” investments), they would form a spectrum, from very low risk on the left to very high risk on the right.
On the extreme right are speculative instruments such as foreign exchange and crypto. These are highly volatile and unpredictable. They will make you money if you time them correctly, but there are very few people who do. They do not fit my (or Warren Buffett’s) definition of a genuine investment, which is when your capital is used constructively to generate profits from legitimate business activity.
To the left of speculative instruments, but still at the far right of the risk spectrum, are investments in entities that fall outside most protections provided by our regulators. These include property syndications, shares or debentures in private (unlisted) companies, venture capital schemes, and offshore investment funds in jurisdictions with relatively lax financial controls. They are mostly legitimate, but sometimes only borderline so, and sometimes they’re downright dodgy.
If one of these investments is offered to you, do as much research as you can on the scheme before committing your money, and then only money you can afford to lose. If you are looking for an investment for your life savings, stay well away, no matter how enticing the advertised returns or how convincing the salesperson is.
Moving further left on the risk spectrum, we enter the more familiar territory of regulated investments. These are legitimate savings vehicles and investments that are regulated by the Financial Sector Conduct Authority or the Reserve Bank. They can be subdivided into direct investments – where you invest directly in assets or debt instruments, such as listed shares, government and corporate bonds, and bank deposits – and collective investments, such as unit trust funds, exchange-traded funds, and endowment policies, in which investors’ money is pooled in an investment portfolio.
These may be less risky than unregulated investments and you may be more protected through legislation such as the Collective Investment Schemes Control Act. But don’t be under any illusions: there are still major risks attached to many of them.
How can you lose money in a regulated investment? Here are some of the ways:
• Bank deposits are not entirely risk-free. Although the chances are slim, the bank could go under, taking your savings with it.
• If you are invested in shares or listed property, the values of those assets are subject to short-term fluctuations and occasional market crashes.
• If you are invested in offshore investments, there is a risk that the rand will strengthen against the relevant foreign currency, losing you money in rand terms.
• If your returns, in whatever you are invested, do not match inflation, you will lose money in real (after-inflation) terms.
Collective investment schemes (unit trust funds and exchange traded funds) are risk-graded according to what they invest in, ranging from low (cash and bonds) to high (equities and listed property).
Broadly speaking, of the equity funds, the general equity funds (those that spread their portfolios over all sectors of the JSE) are lower risk than those that specialise in specific sectors, such as financials, industrials, and resources.
Don’t avoid risk, manage it
Your financial adviser will tell you that, in order to make decent returns over the long term, you need to take on a certain degree of investment risk, and that this risk can be “managed”.
Safe, low-risk investments, such as bank deposits, are appropriate vehicles in which to “park” your money for the short term, but to make inflation-beating returns over the long term (more than five years) you must be at least partly invested in higher-risk “growth” assets, such as equities and listed property. Over time, market ups and downs are smoothed out and you stand to benefit from the “magic of compounding”.
Your adviser will also tell you that a good way to manage risk is through diversification. If your portfolio is diversified – invested across asset classes – you spread your risk because the market cycles of the different asset classes tend to be “out of sync” with each other – in other words, when one is going down, another may be going up.
So if you are a responsible investor, prepared to take a calculated degree of risk in the hope of making decent returns over the long term (at least five years), and wanting a diversified portfolio that is managed on your behalf by an investment expert, where do you turn?
Thousands of South Africans have turned to multi-asset unit trust funds. These funds can invest across asset classes, and have a fair proportion of their portfolio in growth assets, depending on their sub-category (low-equity, medium-equity, high-equity, and flexible).
Figures from the Association for Savings & Investment SA show that domestic multi-asset funds are among the most popular forms of unit trust investment among South Africans. According to its report for the third quarter of 2024, half of the collective investment scheme assets were in multi-asset portfolios.
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