This month marks 10 years since a little-known bank in northern England became a worldwide brand for all the wrong reasons.
Northern Rock was eventually nationalised and the savers’ deposits secured.
But the global financial crisis, as it became known, had begun and it would unfold throughout 2008 and result in the collapse of major investment firms such as Bear Stearns and Lehmann Bros.
Looking ahead to 2017 it might be time to review your risk profile
If your investment portfolio lost 20 per cent overnight, what would you do?
a) Invest more funds to take advantage of the lower prices?
b) Leave your investments in place expecting performance to improve?
c) Be concerned but wait to see if the investments improve?
d) Cut your losses and transfer funds to more secure investment sectors?
e) Lose sleep – security of capital is critical and I don’t intend to take risks?
These were the options given to investors in the ASX Australian investor study 2017 released last month. The study covered 2300 investors and 1600 non-investors and was done by Deloitte Access Economics.
What was interesting on both this question and others in the study relating to risk was that younger Australian investors were more risk averse than older investors. The age groups 18-24 and 25-34 were more likely to respond to a 20 per cent loss event by transferring funds into more secure investments.
Investors over age 55 were more likely to be concerned but would wait to see if investments improved.
This seems counter-intuitive on a number of levels. Older investors within sight of retirement might be expected to take a more cautious approach and head for a safe haven to park their money and preserve capital. But that was the preferred route for younger investors and it seems unlikely that the financial crisis could have had a significant influence given a 25-year-old today would have been 15 back in 2007 and it seems unlikely that high school students would have been losing sleep over their investment portfolio’s performance – or fretting about their future retirement savings.
A recurring theme in the ASX study is that as investors, Australians are a rather conservative bunch, with 48 per cent in the study saying they prefer stable, reliable returns with only 34 per cent prepared to accept moderate or higher variability in returns.
But there seems to be quite a contradiction between the stated risk appetite of investors and the returns they expect from their investments. One in five risk-averse investors still expect double-digit returns from their investments. The study speculates that financial literacy among these investors may be low and that the risk/return trade-off and the current low-return environment not well understood.
What is also concerning is that 46 per cent of investors claimed to have a diversified portfolio but held investments across less than three asset classes. Perhaps most alarmingly 75 per cent of share investors hold only Australian shares.
The ASX Australian investor study highlights that the concept of diversification – a key way investors can manage their investment risk – is still not well understood.
Let’s rewind to the global financial crisis. From when the market hit rock bottom in March 2009, let’s look at the outcome for three investors who were all invested in a diversified balanced portfolio of 50 per cent equities and 50 per cent bonds when the crisis hit.
Clarity of hindsight
Our first investor decided to cut their losses and get out of their investment portfolio and stay in the relative security of cash; our second investor also felt the impact of the crisis and retreated to a much more conservative bond portfolio. Our third investor opted to stay within the balanced portfolio and hope that investment markets would recover.
If we look at the performance of these portfolios from the end of February 2009 to January 2016, we can see that the investor who fled to cash would have seen a cumulative return of 27 per cent. Meanwhile, the investor who sold off their equities and went entirely to bonds would have seen a significantly higher return at 71 per cent. Yet the investor who stayed balanced and retained their target 50/50 allocation to shares and bonds saw a handsome 93 per cent return – albeit with higher volatility.
Hindsight provides tremendous clarity on the right thing to do – sadly only after the fact. The point here is that even through one of the most dramatic market periods of the past century investors benefited from taking a patient, diversified approach to their portfolios.
For an investor to achieve their goals, it is critical that they have a clear understanding of the role risk plays in their portfolio and how it can help or hinder them from getting to where they need to be.
This analysis reinforces the relationship between risk and reward and the need to have the discipline to take a long-term approach.
From Financial Review – ‘Lessons 10 years on from the global financial crisis’, Updated 19 September 2017
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