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Tanita Conradie*
It’s no surprise that many people have been relooking at their investment portfolios because of the market volatility since 2020. The ups and downs of 2020 and 2021 were followed last year by mostly downs, leaving many investors feeling frustrated.
This has led some to move into defensive positions to minimise their exposure to volatile markets. The problem is that making uninformed changes to your portfolio based on short-term shocks can actually cost you more in the long run.
What I mean by ‘uninformed changes’ is relying on emotion and instinct rather than proven methods. One of these methods is matching your investments to your risk profile.
Before exploring the ins and outs of risk profiling, let’s first look at the performance of three different funds that we offer to our clients.
Conservative vs Balanced vs Aggressive
I’ve chosen these funds because they can be classified as conservative (the Custodian BCI Income Plus Fund), balanced (the Ninety One Opportunity Fund) or aggressive (Global IP Opportunity Fund) based on the assets they’re invested in.
What is immediately clear from these tables is that the conservative fund has delivered the poorest performance, especially in the short term. So, if you’d switched to an overweight defensive portfolio three years ago, you would be worse off than if you’d had a balanced or aggressive position.
One of the biggest takeaways for me is the six-month returns in which the conservative fund has severely underperformed the two other funds. The conservative return is also well below the inflation rate, so you would have lost quite a bit of buying power.
The strong returns in the aggressive fund over five years are understandable because that is what you expect in a fund heavily slanted to listed equities. Historically, stock markets deliver the best long-term returns but that comes at the cost of short-term volatility as we’ve seen recently.
So, what does this mean? Should you stay away from conservative funds and focus more on aggressive funds? Not exactly.
The role of risk profiling
The structure of your portfolio is something very specific to your life stage, your goals and your ability to generate wealth. This is a central theme in investment planning because your investments have to match how much money you’re going to need for retirement, how much risk you can afford to take and how much risk you’re comfortable taking on.
Taken together, these three factors make up your risk profile. And based on these inputs, you and your financial advisor should be assessing and re-assessing your portfolio to ensure your risk is appropriate for your current circumstances.
The first step is to assess how much risk you need to take to reach your financial goals. This usually comes down to an equation measuring how much you need for retirement and how much time you have before retirement.
If you’re in your 20s, then you have at least 40 years to save so you have time on your side. This means you can take on more risk than someone who is 10 or five years from retirement because you have longer to recover from market dips.
You then need to measure your capacity for risk.
If you have a secure job in a growing industry with an entire career still lying ahead, then you probably have a greater capacity for risk than a low-income earner living from month to month. Losing 10% of the value of your portfolio in the short term would therefore be less devastating than for someone with less capacity to survive a loss of value.
Lastly, you must consider your risk tolerance – which is more a psychological assessment than a hard measurement.
You might well be in the position of a secure job in a growing industry and a whole career is still to come, but if you’re conservative by nature and don’t want to chase 10x returns, then your risk tolerance is always going to be low. Taking a bet on Tesla, TenCent or TikTok, then, is probably not right for you.
Understanding these factors that contribute to your overall risk profile is essential to having a healthy relationship with your retirement savings. There often isn’t only one right answer or approach. This is why diversifying your investments is such a popular theme in investing.
Let me leave you with one last table that illustrates this point perfectly. Below is a summary of the performance of a diversified portfolio over the same periods as the three funds listed above which are equally allocated. Makes you think, doesn’t it?
- Tanita Conradie, CFP® professional, is a Financial Advisor at Brenthurst Pretoria [email protected].
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