Risk Management

Connie Bruwer from PC Bruwer and Partners advises on this important topic.

Question:  What is risk?

Connie:  We recently had a look at the concept of risk. According to Investopedia, the definition of risk starts with: “The chance that an investment’s actual return is different than expected …” We all know what has happened in the investment markets. And it was not good. From the residential property market to government bonds and even international investments, all have suffered. Not to mention the stock market. I think in the colloquial, we speak of the risk of investment when the investment environment started to change in a bad way. According to investors there is no risk if rates start rising. Think about how eager people were to invest in new townhouses about two years ago. At that stage it was about rapid growth that could be taken out of the investment.

Question:  How is an investment in companies considered by the stock exchange?

Connie:  It is generally accepted that an investment in companies through the stock exchange is risky, but that an investment in the money market or in a fixed deposit is risk free. But this is not a universal truth. Everything depends on the purpose of the investment and the expected investor.

Question:  Why is this so?

Connie:  If the goal or expectations of the investor was for example to obtain a real (above inflation) return, the risk (probability) is greater that an investment in the money market after costs and taxes, will not achieve a better return than inflation. In fact, people are walking with their eyes open in a trap. If an investor is, however looking at a long term objective (as a young investor saving for retirement or a portion of a retiree’s nest egg) and is investing a sum of money in a diversified portfolio of companies of high quality on the stock exchange, the risk that the investment will not deliver a real return in time is very slim. Over a long time period, and in this case the past 20 years or more, the stock market has recorded a real return of 7% per year, compared the money market that has obtained a pre 1% real return.

Question:  What risk does the money market have?

Connie:  The money market also carry reinvestment risk, which means if you want to invest your money for a period of, say five years in a guaranteed portfolio, you cannot get a good rate again at which you can reinvest the day the investment is paid out.

Inflation may increase during the investment period and interest rates can continue to increase rapidly, thus the attractive guaranteed rate can suddenly become unattractive.

However, if you bought shares in that period, that pays a growing dividend stream, the cash income of your initial investment will only increasing for an indefinite period.

If an investor invests an amount for a short period of time because he received cash from the sale of an asset, and need to use the money again six months later for the purchasing of another asset, there is a very small (if any) risk that he will suffer a capital loss by investing in the money market at the end of the period. On the other hand, the risk is very real that an investment in the stock market over a short period of time will have no or even negative returns.

Question:  What is important to keep in mind?

Connie:  Everything depends on how you position yourself, what the objective of the investment is and what time you have on your side. For one investor, the money market may be risk-free, but for another investor it may hold a lot of risk. Usually, the best solution is to utilize one that combines an investment in the stock market, money market and other assets.

Question:  Thus – what is the golden rule?

Connie:  The golden rule is the pre-setting of objectives and the provision of a strategy on how to achieve the stated objectives.

The way to avoid risk is not to avoid stock, but to understand how various investments work. If you understand that the price for real growth in the long term is always a time of short-term volatility, the return will be met according to your  expectations and then you can sleep well at night.