Risk is something we all live with no matter our age and stage in life. Ultimately, we choose how much risk we are prepared to take, depending on the opportunity and reward that comes with it. Investing your hard earned savings is the same, however sometimes we don’t fully appreciate what the risks are and the impact they might have until it’s too late.
During the school holidays, back when I was growing up, I worked as a farm labourer on my brother-in-law’s farm in Dorie, 50 minutes south of Christchurch. There were plenty of jobs to do, but the thing I loved most was riding the Honda XL 175 farm bike to shift sheep from paddock to paddock and generally muck about on. That was until Larry bought a brand new Kawasaki KL 250. It looked amazing. Frogger green, with 10kms on the clock, it was a sight to behold.
He told me not to ride it until he had a chance to show me the differences compared to the Honda. It was a lot more powerful, heavier, and blah blah is all I heard after that because my 14-year-old brain had already decided to ride it as soon as I could. Which, as it turned out, was later that day.
In my head I had already calculated the risks of doing so. There was the ‘now risk’ of not being able to start the bike, getting caught by my sister Janice, or a chance I might fall off it and scratch it. But I was willing to take that risk.
‘Later risk’ also came into my calculation. This was a biggie. If Larry found out I had ridden it while he was away, the consequences were daunting, to say the least. I might be family but the tagline for the first Alien movie “In space no one can hear you scream” was flashing in my head, giving you some idea of the level of risk I was facing. Ok, I know, I’m being a little over dramatic, but the risk was high none the less.
In two minutes, I had considered all the risks and calculated the return of investment, in this case being excitement, speed and bragging rights with my mates. These far outweighed the possible risks and consequences I had contemplated. So, when Larry left for town and Janice was away playing with the kids I snuck out and took the bike for its first run down to my favourite paddock, which had an irrigation mound that was perfect for jumps. I mean what could possibly go wrong? Bear with me and you’ll find out.
How ‘now risk’ and ‘later risk’ works with your money
When investing, ‘now risk’ looks at the short-term consequences of your investment decision on your investment. Much of this depends on where you put your savings, how long until you need them and for what purpose.
By way of example, if you were to put $50,000 into the stock market and chose three companies you liked and then pulled your investment out a month, or even a year, later you would have experienced a lot of ‘now risk’. That’s because share values can change dramatically over a short period of time and you could have lost a large amount of your hard-earned savings. Putting your money into a cheap index fund would be lower risk, because of greater diversification, but still relatively higher than popping it into a term deposit for a year.
‘Later risk’ is not just about getting your capital back, but more about keeping the buying power of your savings when you need it. Put another way, it’s making sure the returns on your savings keep ahead of inflation. Something, in today’s tough economic times, we all know about.
Using the Reserve Bank’s inflation calculator, if I had $50,000 in 2003 and left it under my mattress for 20 years and then pulled it out, I would still have $50,000 but the equivalent buying power would only be around $30,600 in today’s dollars. Understanding the impact of ‘later risk’ helps you to determine the appropriate amount of investment risk you need to take, depending on what you want to use the funds for in the future.
If that $50,000 was for the deposit on your first home, then it’s likely you will be using those funds in the short term. So, a bank deposit could be a good choice because the key is getting your capital back and then, hopefully, earning a little interest along the way.
However, if it is for your retirement and you have twenty or thirty years before you want to use those savings, then investing in a well-diversified portfolio of growth and income assets, like shares and bonds, will, over time, give you a better chance of keeping ahead of that true robber of money - inflation.
Getting the balance right is very important: there is no one size fits all approach when it comes to investing and retirement. That’s because we all have different priorities, at different times, so getting some qualified financial advice will help you get the right investment mix for your own personal circumstances.
Getting back to my original story I did race the bike over the jump and it went well. So well, I decided to give it another go on the way back, but this time with a bit more throttle. As it transpired, I did a great jump but had underestimated my speed-to-fence ratio. Before I knew it the bike hit the barbed wire fence, swiftly followed by me, ripping my leg and arm in the process and knocking myself out.
I awoke to a screaming engine and manged to limp over to the bike and hit the kill switch. I then managed to get myself and the bike back to the yard, both of us far worse for wear and tear than we had been before the ride.
The ‘later risk’, when Larry came home, I’d calculated about right (and well deserved to be honest). It was a lesson well learned, acknowledging that a 14-year-old brain is not great at determining the best decision based on all the risks presented, and that it really pays to listen to expert advice.
Disclaimer: David Boyle is Head of Sales and Marketing at Mint Asset Management Limited. The above article is intended to provide information and does not purport to give investment advice.
Mint Asset Management is the issuer of the Mint Asset Management Funds. Download a copy of the product disclosure statement here.
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