Getting a high return on investment is easy. To get high returns, all you need to do is have a greater proportion of shares and property in a fund: if you buy more shares and property and reduce the amount of fixed interest and cash, you will inevitably get higher returns. Easy.
It hardly needs saying that such a move also means greater risk. Change the risk setting and you will surely get higher returns –but the ups and downs of a portfolio that is loaded up with shares and property will give you an investment roller coaster ride and that may be an uncomfortable, scary ride.
Whatever returns a fund gets have to be adjusted for risk. When investment managers boast of high returns, the obvious question to ask is how they are getting those high returns.
There are two probable explanations for high returns: first, it is possible that they are getting better returns because they are highly skilled, smart investors. Some investors are better than others and dedicated, skilled investment managers can get higher returns without taking on more risk.
Investment skill, allied with good investment processes and judgement, can and does lead to superior returns.
However, the second possibility is that those high returns are simply achieved because the investment managers have taken on more risk. Investors need to be careful of this because it is the easiest thing in the world to get better returns by taking on more risk.
After all, investment managers are not putting their own money at risk – it is your money that suffers the roller coaster ride.
The problem with a portfolio that has a lot of extreme ups and downs is that the volatility will often rattle people out of the market. When a GFC-like event comes along, people find that they cannot tolerate the roller coaster ride as well as they thought they could. And then they sell, usually right into the bottom of the market.
I have seen this happen often over the years: when times are good people buy into a market for high returns. However, when the market falls and panic sets in, they sell out and, frequently, take a significant loss. This is the very opposite of that old adage which says to buy low and sell high.
It is for this reason that the investment process should always start with consideration of risk tolerance first and only then should investors think of returns. Regrettably, this is the opposite of the way that many people approach investment: they look for high returns first and afterwards (perhaps) give a fleeting thought about risk.
Whether it is your KiwiSaver account or some investments, take a moment to consider your appetite for risk. Complete a questionnaire (see www.sorted.org.nz) to find out what amount of risk is right and then (and only then) worry about returns.
Martin Hawes is the Chair of the Summer KiwiSaver Investment Committee. He is an Authorised Financial Adviser and a disclosure statement is available on request and free of charge, or can be found at www.martinhawes.com.