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While Aussies are known the world over for being laid back, it seems we’re a bit more circumspect when it comes to money.
New figures have revealed our appetite for risk is far below the global average, with just 29 per cent of investors prepared to increase their risk profile compared to 66 per cent of investors globally.
So, why is our appetite for risk so low and what are Australian investors missing out on?
According to Adam Dawes of Shaw and Partners, most new investors are far more risk-averse than they realise. In fact, many wrongly assume they have a high-risk profile.
“Everyone’s got a plan until it all goes wrong… When we talk about risk, we say ‘are you willing to stomach a 20 per cent fall?’ No, but we want to make a million dollars. We say ok, we can do that, but there’s a risk,” Dawes told Trading Day.
“As soon as we invest it and it starts to lose some money, they say ‘get me out’…When they start losing money, that’s when the true colours start to come out.”
According to studies, this reaction makes sense. Work by behavioural psychologists show that people feel the pain of loss about two to three times more than the enjoyment they get from gains, Chris Brycki, founder of investment app Stockspot, told Trading Day.
“That makes it very difficult for people to own a portfolio for a very long time if they’re paying attention to it every day.”
In fact, studies have found regular ‘mum and dad’ investors tend to do around three per cent worse than the overall market because they emotionally react to market swings at the wrong time.
Younger investors are warier
Contrary to popular belief, research conducted by the ASX indicates younger people appear to be more risk-averse than the older generations.
That’s despite conventional thinking which states that younger people should buy riskier assets to achieve a bigger return in the long run.
Andrew Campion, head of investment products at the ASX said there are a few theories about why this could be the case, including the rising cost of living and the desire to put more money into a home.
In the study, most people between the ages of 18-34 said that if the market fell 20 per cent they’d either lose sleep or sell their portfolio – both things that shouldn’t happen, according to Brycki.
“I think there’s a lack of financial education around what risk means, and risk isn’t a bad thing as long as you’re taking it at a time that’s appropriate for your time horizon,” Brycki said.
“Really your time horizon is important because as you invest for longer your probability of doing well increases.”
Working out your profile
Campion says there’s a simple test you can give yourself to measure your level of risk adversity.
Consider this gamble – if you were offered the chance to walk away with $1,000 or given a five per cent chance at winning $100,000, what would you do?
“Even someone with the most rudimentary knowledge of statistics would know that the latter bet is statistically the most profitable… but it’s amazing how many people would probably take the certain $1,000 gain rather than the riskier bet,” says Campion.
“That’s what investing in the equity markets is all about, it’s all about probability, it’s all about statistics [and] it’s all about risky bets, in essence.”
He says a good measure of what your risk appetite actually should be is to consider the market swings of a broad market index such as the ASX200.
If your portfolio is twice or three times as risky as that benchmark, you can expect to see much sharper falls on a regular basis.
Your time horizon
“Think of a situation where the market has a much sharper fall… a five, 10 per cent fall in a matter of days or weeks. If your portfolio is twice or three times as risky as the benchmark you’re going to be wearing a loss of 20 or 30 per cent,” Campion explained.
“How is that going to make you feel? Are you going to be treating it like the market’s on sale and go in and buy more or will you say – I need that money in a couple of years for a house deposit or a holiday, I’m going to cut my losses here.”
Ask yourself, can you keep the money invested for decades, or will you need to have it available in the next few years? That will determine how high or low your risk profile should be.
“That simple rule of ‘buy low and sell high’… it’s amazing how often people end up doing the opposite and they chase the hot stocks… and they end up buying high and selling low,” says Campion.
Market conditions frequently change, which means that once conservative investments can easily turn volatile.
Understanding your capacity for risk is one thing, but investors also need to be aware of how much risk they’re carrying based on market conditions, Brycki warns.
“Nobody knows if shares are going up this week, this month or this year… [so] make sure you’ve got some other investments in your portfolio that will provide some sort of cushion if markets fall,” says Brycki.
“Last year Australian and global shares fell. In fact, 93 per cent of asset classes around the world fell, at least in US dollar terms.”
However, there were a few asset classes that outperformed, such as Australian bonds, gold and Australian cash – three asset classes that typically do well during times of volatility.
Brycki says unless you’re investing for numerous decades, it pays to hold a number of conservative investments to offset the market falls.
“Every six months you should be looking at your portfolio, understanding what’s going on, rejigging your portfolio and looking at whether you need more cash, more international exposure… Because over the longer term, asset allocation will do better for you,” Dawes advises.
Watch the discussion in the interview above.