Latest / The Curve / RTC4: Understanding the fundamentals of risk

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RTC4: Understanding the fundamentals of risk · The Curve

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Welcome to the Curve Podcast, a conversation for women who want to learn more about money,
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their money for the future they want to have.
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We're all busy in the pursuit for financial confidence and increasing your wealth should
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be a simple one.
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That's why the curve was created.
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This podcast is for women to learn about investing in a non-scary or intimidating way.
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With short episodes you'll have time to learn, digest and understand everything to do with
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the world of investing.
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You don't expect to be an expert on day one, no question is a silly question.
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If you're asking it, so is everyone else.
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So thank you for being here and for listening because together we really can raise the curve.
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Welcome back, how exciting.
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It's so far Vic.
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Yeah, hi everyone.
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Everyone, I hope there's people listening.
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I know.
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Hi one person, it's here listening.
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No, but I must say it does make me feel kind of good to think about there being lots of other people
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in the classroom learning with me.
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Yeah.
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Today we, um, I love that I'm trying to lead.
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That's what are we talking about today.
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So the last episode we talked about kind of risk and return and compound interest.
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But I think that there, those are really fundamental important things when it comes to investing
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in finance.
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So I think we should maybe dig a bit deeper into those and yeah, kind of talk about what
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is risk.
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We talk about risk and return and what's risk and return and it's like, but what is,
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what is risk?
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Can I put it, can I put a figure on it?
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Can I quantify it?
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Yeah.
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Is there too much risk?
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Is there too little risk?
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And I think the most difficult thing is that it's, it's so subjective and it's so dependent
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on your situation that there isn't a quantifiable figure for risk.
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It's not 10 or 20 or 1% or 2%, you know, like it's very much.
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It's fluid, isn't it?
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Yeah.
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And it's, it's, it's a combination of a number of things.
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It would be so awesome if you could do everything you can to minimise the risk to the point
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where there isn't any, but that's just not the reality of investing, is it?
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No.
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And I guess that is what everyone's looking for is the investment that is low risk and
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high return.
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That's what everyone wants.
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And in reality, you want to be compensated for the risk that you're taking and that
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compensation comes in return as the return of the investment.
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So if you're taking a low risk approach to investing, you say you're investing in
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term deposits, your niche, which is our cash class, exactly.
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You're only getting kind of 1, 2% because you're not taking the risk.
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It's kind of like, why should we reward you if you're not going to take the risk?
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It's kind of like your view of risk might be like, oh, I'm going to cross that bridge
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because I'm so scared of heights.
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Whereas for me, I might be like, I do that every day.
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That's not risky for me.
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So it's kind of, I want to jump today like a bungee jump.
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You might love bungee jumping and that's not risky for you.
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You get the thrill out of it whereas for me, like, oh my gosh, I hate bungee jumping.
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I thought I'd be even standing on the bridge.
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That kind of, the definition of risk is different for both of us.
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Right.
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So it's finding and understanding where is your safe zone, what you can afford, how much
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risk you're willing to take and that that's going to be different for everyone.
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Exactly, exactly.
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And when we talk about risk within investments, it's the volatility, it's the movement
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up and down of the sheer price, it's the, or the asset class, if you're investing
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in property, it's the move up and down of, of house prices, it's, it's the uncertainty,
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it's sitting there going, okay, I'm investing in this investment.
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And I think it's going to generate 10% return in 12 months and it doesn't, at the end
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of 12 months, it's down 10% for example, can you stomach that?
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That's the unexpected return, I guess, is what risk is.
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And risk can be positive.
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You can, by the end of 12 months, that investment could be up 20%.
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So it's risk, it's kind of either side of what you expect.
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So do you think then a good, a good way to figure out what your risk appetite is, would
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be to think about what's the worst case scenario and would you be okay with that?
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Yeah, that's a good way of looking at it.
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But it's hard though, because you say, you know, it could be 10% up or 10% down, but
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the reality is it could be 100% down, right?
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And that's the risk associated with investing in shares and, yeah, it's kind of the risk,
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the risk you take for the return.
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I mean, you could sit on cash and get 1% in the bank and be quite happy with that.
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It's kind of like with an entrepreneur, they take a lot of risk, they put themselves
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on the line when they start businesses.
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And I can't remember the stats I saw on my head, but it's like 25% of startups actually
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survive.
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And it's kind of small.
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It is.
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You see, there's people time and time again, or startup business doesn't succeed, startup
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business doesn't succeed.
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And then it's like the fourth or fifth one that does well and the payoff is like at times
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can be significant.
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They take risk after risk after risk and, you know, they might be living kind of the bones
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of their ass for a good couple of years just to get that, that one idea, yeah, those
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people are very high risk.
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And then there's other people that are like, hey, I'm very comfortable in my job, getting
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my salary, getting that every month and just living paycheck to paycheck, being a bit
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more comfortable in my lifestyle.
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Some people like the thrill and want to take a bit more risk, even though the payoff
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might be negative 10, negative 20, negative 30.
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It also could be plus 10, plus 20, plus 10, you know, it could be quite significant.
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So it's frustrating when people say that investing is like gambling because I don't think
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it is.
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You are making, you're researching an educated decision and you're looking at the current
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situation and current environment and yeah, okay, there's a lot of investors out there
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that take a pun tour, do treat investing like gambling, but I think if you do your research
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and you find a good business and you want to invest in it, then that's not gambling.
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You're actually taking the time and energy to make a decision that you think will benefit
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you in the long term.
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I love the way that you explain that in terms of different people's lifestyles because
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it's like a continuum, isn't it?
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There's some people who will be the riskiest investors and then there's some people that
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will be the safest investors and it's just figuring out where you are.
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And we do say, if you've got a longer time horizon, collectively that those people can
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take more risk, but some of those people might not want to.
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People like our age in their 30s who aren't retiring until or maybe don't need the investment
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for 10, 20 years, they can take more risk, but they might not want to and that's fine.
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It's totally up to them, but the age old saying is if you're younger, you've got a longer
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time horizon.
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If you need your money in the next 12 months or even two years, I would say it would be
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considered short term in my opinion, then maybe the share market's not for you because
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you or maybe you should look at an alternative asset class that's a bit of a bit lower risk
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if you need those funds within the short term.
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So I'm nearly 30, don't have any kids house, etc.
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How would I figure out where I fit on that continuum?
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How would I know or try and figure out what level of risk I'm comfortable with?
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Yeah, it's frustrating because there's no definitive answer and it's totally subjective,
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but I kind of come back to I guess three points that I would think about when it comes
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to risk.
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Firstly, know what you can afford to lose.
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So kind of ask yourself, what would happen if you lost some or all of the money that
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you're putting into these investments?
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Would you still be able to have a lifestyle you have?
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Would you be comfortable with that and it's just finding out what you can afford to lose?
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The second one would be, what are your goals and your timings?
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Do you need this money in 12 months, in two years or in 10, 20 years?
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What dollar amount does that look like to you?
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And be realistic here, don't be like, I won a million dollars in five years time.
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Hey, but if you do, you can take a lot of risk to do that.
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So it's kind of that time horizon and what that goal looks like for you.
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For example, say you wanted to buy a house in five years time and you needed a hundred
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thousand dollar deposit and you wanted to put in 50,000 now as an investment and you wanted
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to get that to a hundred thousand in five years time.
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So you want to double your money, then you're kind of looking at around 15% return per
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annum on average over that five year period.
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So yeah, you might have years where that's up 20 and you might have years where it's
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down 10, but overall the average of doubling your money in five years is 15% return per
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year.
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Is that even realistic?
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I have no idea.
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Well, that's the thing.
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In order to get that 15%, you'd need to take a bit of risk.
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And so it's just kind of understanding what your goals and your timings are.
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And then the third point, I would say, is what we touched on with the bungee jumping
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analogy is you need to understand what your personal risk attitude is.
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So knowing what you can afford to lose, knowing what your goals and your timings are, and
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then also what your personal risk attitude is.
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So are you a risk seeker or do you not like risk at all?
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Then that's I guess the best way to think about your risk.
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So can we go back to that example you said of say say a couple has a hundred thousand
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dollars and they've got 50,000 dollars that they're wanting to invest to try and double
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that as you said in five years time.
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Is there a way that they can calculate the amount of risk they need to be taking to achieve
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that?
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If you're going to invest in a fund, then a lot of the fund managers out there have a
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risk calculator and it lumps you into, it asks you a whole lot of questions and will lump
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you into a category of which fund to invest in, whether it's a high growth, aggressive fund
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or if it's a cash or like low risk conservative fund.
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But no returns are guaranteed either so it's not like you can say coming back to that
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example of you want to get 15% return to double your money.
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There's no investment that can guarantee you that.
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It's the non-guarantee that creates the risk if that makes sense.
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If everyone knew what the market was going to do for the next five years, then all those
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returns would be eaten away because everyone would be investing.
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So it's difficult and it's frustrating that I can't give you the definitive answer but
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the risk is the volatility or the uncertainty of the investment that you're making.
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That's the thing with the market.
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It's so fluid and there's always uncertainties out there so you never know what you're going
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to get in terms of the outcome.
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Nobody knows what the market's going to do tomorrow, even some people say they do but
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they don't.
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So it's...
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It's risky business.
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Yeah and it's, I guess another way to look at it is don't just look at return, look at
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the risk associated with that return.
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If someone comes up to you and they're like, oh my gosh, I just made 100% on this investment
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in the last two days, it's like, okay well done you but the risk associated with that
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is so high and I personally I think that is more luck than skill.
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You've invested in something, you've had a quick win, that's not investing and that's
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not sustainable.
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Investing in a quality company, like Microsoft for example, I love Microsoft, is that a hot
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tip?
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If there's a person Microsoft?
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No, we don't give advice on this Microsoft.
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Microsoft for example, that business has generated about 35% return per year for the last
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five years.
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Well, so that is more than doubled.
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Yeah, you've kind of got to look at what quality businesses are out there that you think
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can double in the next five years and therefore you'd invest in that and hopefully your 50,000
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would turn into 100,000.
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But how is that risky if you can already see that that's what's happening?
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Do you know what I mean?
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But you can't.
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That's the thing.
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It's all a prediction and what you think based on what they've done but not necessarily
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guaranteeing.
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Yeah and I mean we'll touch on it in maybe in a few episodes time around how to find
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these ideas and then how to pick a winning investment to almost reduce your risk and
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order to invest in something that will grow over the long term.
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It's so hard because I wish I could just draw your brain and put it in mind for a moment
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because I think all this stuff seems so natural to you.
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If you just threw a dart at a dart board, the likelihood of you hitting the bull's eye depends
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how good you are at darts.
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Terrible.
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Terrible.
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So that is pretty low.
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If you could practice and practice and practice and practice, then the likelihood you get
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closer to that bull's eye.
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So that kind of comes back to investing in, I'm not saying that investing is throwing
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darts at a dart board.
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I'm saying that if you put your time and effort into something, into a skill, the more you
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do it and the more practice you have, you start to reduce the mistakes that you're going
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to make and reduce the, hopefully, the poor investment decisions.
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So you stop hitting the wall and actually you stop hitting the wall and you get closer
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to the bull's eye and I think within investing, it's very much about doing and learning
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by doing, which, when you first sight out, could mean losing money, but, hopefully in the
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end, you'll start to realise, okay, why has that investment done well and why has that
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one not?
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And you'll start to eventually kind of move up the curve in terms of investing in what
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works, what succeeds and therefore what gets you a good return and gets you to that doubling
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of your money in five years.
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Oh.
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Does that?
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It's kind of frustrating because risk is never an easy thing to understand or an easy
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thing to define, but it's just really important to look at when you're looking at the return.
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Back in the global financial crisis and we had a lot of finance companies collapsing in
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New Zealand and I watched Wolf of Wall Street last night and, you know, they get these stock
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brokers that are on the phone saying, you know, back in the cowboy days and they would
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be like, you know, you're going to get this huge return and your investment and it's just
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knowing, like, okay, but what risk am I taking with that?
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But when you say what risk am I taking with that, is that you saying, okay, what's the worst
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case scenario?
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Yes.
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It's also knowing what, what questions to ask.
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I guess if you're investing in the likes of a term deposit, it's pretty much guaranteed
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return and that you, it's a fixed period of time and you know the banks said they're going
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to get delivered, kind of say 1.2% over that six month, 12 month period, whatever it is.
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So that's low risk because there's, there's low uncertainty.
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There's low volatility.
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Because you're told what you're getting.
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You're told what you're going to get.
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Exactly.
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And similar to a bond, a little bit more risk, but it's a set period of time, the bond
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you're buying off that company has told you you're going to get 2, 3% for a fixed period
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of time.
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And it's a reputable company.
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It's somewhere where it's low risk because it's already successful, they're not going
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to use that money in a crazy way.
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Exactly.
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So if you look at your time horizon, coming back to the term deposit example, you look
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at your time horizon, you know, okay, in 12 months time, I'm going to get 1.2% for example
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at the end of that 12 month period.
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When it comes to investing in shares though, there's more uncertainty because you don't
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know what that end share price is going to be.
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Because you don't know and because there's a much more uncertainty and possibly volatility
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in the share price, your expected return is unknown.
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You might look at previously what the share price is done, but that doesn't give you an
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indication of what it's going to do in the future.
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You're buying that share on the premise that it might do 10%, but it might do negative
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10%.
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And I think that movement away from what you expect is risk.
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So if I could draw a graph, for example, I'd have in the corner zero and then your term
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deposit would be a very low, but straight line over a time period and say, you know, time
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on the horizon to access and return on the flex, do I have other hands and we're just
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shooting every one of us, so you've got return on the vertical time on the horizontal term
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deposit would be a very low, but, but straight and steady line and and shares, for example,
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or equities investing in the stock market, whatever you want to call it, would be kind of
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it up and down, up and down, up and down, but at the end of the same time period, you'd
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be at a much higher rate.
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But not necessarily though, not necessarily, but that's why we say long term because markets
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move up and down and generally over the long term say plus five years because you're taking
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more risk, you will hopefully, and I don't hold me to this, but hopefully because you're
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taking more risk, you're going to get a higher overall return in the long run.
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It's a really good way to explain it.
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I think.
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Cool.
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Yeah.
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Thank you.
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I'm not finally sort of on the side of that.
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If I could show you a graph, that'd be a lot easier to explain.
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So when you say in terms of a long term, I know you've just used five years as an example,
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but are we talking 20 years, two years, like what is a long term perspective?
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My opinion short term is anything less than two years, medium term, be two to five
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ish, maybe two to ten, long term would be five plus, I mean, even that's bit too short
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to be honest, five years in the scheme of things is pretty short.
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So anything kind of beyond five years would be mid to long term investment.
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And you know, when you talk to fund managers in the market, they always say five years
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is kind of an industry stock standard of an investment time horizon, and that's just
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because the market moves up and down.
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A risk is a movement away of your expectation.
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The term deposit, you know what you're expected to get with a share you don't.
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It's a movement away from your expected return.
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It's also, I think, it's so goes against everything that you learn when you're growing up
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in terms of you're stepping into the unknown.
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And that is what's scary and that is what is the risk, right?
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And that's why people, some people just hate investing in shares.
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Too much anxiety, not having an...
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Exactly, no one answer or...
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Yeah, and that's fine as well.
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It also comes back to that argument of what is your level of your fear or what is your
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fear factor and what is your kind of risk appetite?
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Working new sit without biting all your hands off.
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Exactly.
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And being just like an anxious mess and where's like a comfortable level of risk.
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What I'm not realizing, I mean, I keep coming back to COVID because it's such a relevant
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example is, you know, if you'd invested, say, at the beginning of last year, beginning
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of 2020, and say $100, and then the market, the market fell like 30%.
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And the ability to sit there and go, hey, that's fine.
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I'm taking a long-term view.
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I'm not going to freak out and take my money out because when the market falls 30% and
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say your investments fall in 30%, that's only on the screen, it's only on the paper.
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As soon as you actually cash out and sell that, that's when you have crystallized that
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loss and now you've only got $70.
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So it's the ability to sit there and go, hey, I've only just started my investing journey.
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I said I'd give it five years and, you know, now the market's kind of way above levels
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of the beginning of last year.
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So if you had taken up your money, you'd be in much worse financial position than if
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you'd just sit there and go, hey, that's fine.
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Yeah, I gave myself five years, it's only been 12 months and, yeah, hopefully another
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four years time, your investment will be a lot higher than $100.
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It's actually kind of cool to think about it like that because, you know, when you're
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in a shit time in your life or something's not going very well and everyone's like, hang
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in there, it's going to get better.
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You know, whether it's a break up or it's your job or anything, there's that fear of
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the uncomfortable stage of anything, right?
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And also then not knowing how things are going to work out, but come back to that patience.
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Patience is a big one, yeah, patience is a big one.
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And it can work in the other way, like if you have $100 investment and it doubles and,
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you know, the number of people that sit there and go, yeah, that's just on paper.
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You haven't actually cashed out and crystallized and then solidified that gain.
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You could wake up tomorrow and it's down to $70 again.
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So it's kind of, that's why I always tell people, don't look at your investment every day
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because I be super distracting and be, you give yourself that goal and that time horizon
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for a reason, stick to it and make sure that you're not checking your investment every day.
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But also on the flip side of that, it's not a countdown to that period of time.
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Come back to the previous example, so we've been, we're starting investing at the beginning
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of 2020, we're now 12 months in and, you know, we've now got four years.
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So maybe do we kind of change to a lower risk investment and that's, that might be moving
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between asset classes, it might be allocating a bit more to cash than I had in my shares.
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So it's, it's a rolling countdown.
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So say we've got 12 months left of our investment time horizon, maybe we move into a little
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bit more of a lower risk investment because we've only got 12 months now, not five years.
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So it's kind of assessing your own risk appetite and your goals and your timings.
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So looking at it, it's this kind of a countdown, not as a fixed period of time.
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It's a moving goal post.
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Yeah, it is.
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But it's also not, not taking your money out, say every year, it's more saying if you're
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going to invest more, okay, now I've only got 12 months, maybe obviously in a lower
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risk.
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Okay, it's not taking your money out every, every year and we're assessing, it's more
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just saying, if I'm going to invest now in my time horizon as now, at least it's now
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only 12 months, whereas four years ago, I was, I was trying to try a risk because I've
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got a longer time horizon, every time I try and talk to what you've said, I feel like
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I sound stupid.
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But this is what I'm making up on is it's like you don't celebrate or cry over the losses
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or the wins as you're going along.
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So until you cash out, that's where you end up, it's not that along the way you need
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to be like, woo, we've gone five percent here and oh my god, I've lost ten, it's actually
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just knowing that that is just a waste of time and energy to be so emotional, like imagine
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checking your investment, I don't know, say every, every couple of months, you're like,
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oh my god, I'm up 10, I'm down 10, like emotional roller coaster, yeah, that's exhausting,
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it's kind of putting it away, checking it periodically, which could be every six months,
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for example, or if something changes in your situation.
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And that's a really hard thing that I've had to learn in my job because I do look at
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it, I do look at investments every single day and there's days when, when things are
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invested in for clients are down 10, 20% and you kind of have to look at it objectively
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and go, okay, don't get caught up in the emotion, today's a new day I'm investing, everyone
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always makes mistakes and sounds like a cliche but that's when you learn the most about yourself
22:49
and about your investing strategy and you say, okay, what did I miss?
22:54
Why did that investment not go the way I thought it would?
22:58
And that's when you incrementally become a better investor because you start to learn
23:03
what works, what doesn't and what am I missing and what should I be considering for the
23:07
next investment.
23:08
So taking a positive view, but also, yeah, like you said, not celebrating your money, it hurts
23:13
though, doesn't it?
23:14
Oh, totally.
23:15
And it's taken me, it's taken me a while, definitely, to learn, and especially when it's
23:18
clients money and you're kind of sitting there going, oh my gosh, but as long as you've got
23:23
more winners than losers, then you'll be fine, okay.
23:26
So when you're investing, your time horizon is so crucial and yeah, if you want to quick
23:30
when, go to the casino and not the share market, I hate the casino, you'll never see
23:36
me at a casino.
23:37
The long nails freak out.
23:39
And if you have the capacity to hold your investment for kind of five or ten years, then what
23:43
happens next week or next month doesn't really matter in the scheme of things and don't
23:47
get too hung up on it.
23:48
I think we might have to talk about diversification in the next episode.
23:51
Yes, I think diversification is a whole nother can of worms.
23:55
We should save that for any episode itself because it's really important to understand
23:59
why.
24:00
So diversification, when it comes to your investing life and your investing journey is so, so
24:05
important.
24:06
And this is the eggs in one basket, isn't it?
24:08
Yeah.
24:09
All right, cool.
24:10
Diversification, it's quite a funky word.
24:12
I'm hoping I can use it more actually knowing what it means, so diversification next
24:16
time.
24:17
Cool, thanks.
24:18
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24:24
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