Risk, time and your goals: finding the right mix

What risk really means

Most people think of investment risk as a bad month on the market: prices fall and your statement shows less than before. That is one kind of risk — short-term ups and downs in value, often called volatility. For a well-spread investment it is often temporary. A fall tends to become a lasting loss mainly when you sell while prices are down.

The second kind is quieter: the chance that your money does not do the job you need it to do. Retiring with too little. Falling short when the university fees are due. Nothing dramatic happens on any single day, so it is easy to overlook.

The two pull against each other. Investments that move around least have tended to grow the least over long periods, and those with the most growth potential tend to give the bumpiest ride. Managing risk is about deciding which kind you take on, and when.

Why your time horizon matters most

Your time horizon is how long it will be before you need the money. It matters because time changes which of the two risks is the bigger threat.

Over a short period, the ups and downs dominate. If markets fall just before you need the money, there may be no time to recover and you could be forced to sell at a low point. Over a long period the picture tends to reverse. There is time to sit through rough patches, and the bigger danger becomes growing too slowly — particularly once inflation is taken into account.

A time horizon belongs to a goal, not to a person. The same household can have money it needs within months and money it will not touch for decades, and each pot can be invested differently.

The building blocks and how they tend to behave

Almost every investment, whether a unit trust, a retirement annuity or a tax-free savings account, is built from a handful of asset classes. Each has a typical character, although none of it is guaranteed.

• Cash. Bank deposits and money market investments. Stable and easy to reach, which suits short-term needs. Over long periods cash has tended to grow the slowest and may struggle to keep up with inflation.
• Bonds. Loans to government or companies that pay interest. They generally offer more income than cash with moderate movement in value, although prices can fall when interest rates rise.
• Listed property. Shares in companies that own buildings and pass on rental income. It can offer income and growth, but values can swing as much as shares.
• Shares. Part-ownership of companies, also called equities. Over long periods shares have tended to offer the most growth potential, along with the sharpest short-term falls.
• Offshore. Not a separate asset class, but any of the above held outside South Africa. It spreads your money across more economies and adds exposure to the rand exchange rate, which can help or hurt.

Cash and bonds are often called the steadier assets; property and shares, the growth assets.

Diversification: not relying on one thing

Because asset classes respond differently to the same events, they seldom all struggle at once. Diversification means spreading your money across asset classes, industries, companies and countries, so that no single disappointment can badly damage the whole.

It does not remove risk, and in a severe downturn most things can fall together for a while. What it tends to do is narrow the range of outcomes, which makes it easier to stay invested. For most people, pooled investments such as unit trusts are the practical way to get that spread. Several funds that all hold the same large shares are, in effect, one bet.

Risk tolerance versus risk capacity

Two separate questions are at work here.

Risk tolerance is emotional: how you feel, and what you do, when your investment falls in value. Someone who would lose sleep, or sell in a panic, has a low tolerance whatever a spreadsheet says.

Risk capacity is financial: how much of a setback your situation could absorb. It depends on your time horizon, how secure your income is, who depends on you, and whether emergency savings and adequate cover are in place.

The two do not always agree. A young person with decades ahead may have plenty of capacity but little tolerance; a confident investor close to retirement may have the reverse. A sensible mix usually respects the lower of the two.

Three goals, three approaches

Take three common goals. These are general illustrations, not recommendations — the right mix depends on your own circumstances.

1. Short term: money you will need soon.A deposit, a planned renovation or your emergency fund. There is little time to recover from a fall, so stability and easy access usually matter more than growth. Cash and similar low-risk investments tend to fit.
2. Medium term: a goal some years away.School fees for a young child, or replacing a vehicle. There is some time to ride out dips, so a balance of steadier and growth assets is common, leaning more cautious as the date approaches.
3. Long term: many years or decades away.Retirement for someone in mid-career. Short-term falls matter least and inflation matters most, so growth assets, local and offshore, typically play the biggest part — provided you can live with the bumps.

Why reviewing matters

A mix that was right when you chose it will not stay right by itself.

• Your horizon shortens. Long-term money eventually becomes short-term money, and the mix generally needs to shift with it.
• Markets move the mix for you. After a strong run, shares make up a bigger part of your portfolio than you chose. Bringing it back to the intended proportions is called rebalancing.
• Life changes. A new job, a child, an inheritance or a retrenchment can change both your goals and your capacity for risk.

A review once a year, or when something significant changes, is usually enough. Changing course after every market wobble tends to do more harm than the wobble itself.

How VyroPlus helps

VyroPlus is an authorised Financial Services Provider based in Kimberley, and investments are one of the eight areas we help with. A conversation about risk and your investment mix usually covers:

• what each goal is for and when you will need the money;
• how you feel about movement in value, and how much of a setback your finances could absorb;
• how your existing investments, retirement savings, cover and emergency money fit together;
• the costs and risks of each option, in plain terms, and how reviews could work as your life changes.

There is no obligation, and no return is ever guaranteed. The aim is that you understand what you are choosing and why.

Questions to ask

Before you choose or change an investment mix, it helps to have answers to these:

• What is this money for, and when will I need it?Give each goal its own time horizon.
• How would I react if it fell sharply in value?A plan you can stick with is worth more than one that only works on paper.
• How much of a setback could I afford?Think about income, dependants, emergency savings and cover, not only your nerve.
• What is actually inside my investments?Ask for the split between cash, bonds, property, shares and offshore across everything you hold.
• When will the mix be reviewed?Agree how often, and what would trigger a change.