Explaining risk to an inexperienced investor is tough. We all see risk differently. Our tolerance for risk is influenced by factors like our age, our investing history (or lack thereof) and even our family background, all play a part.
We need risk to get a return but the bigger the expected return the bigger the risk. Not all risks are the same and not all are worth taking. To explain risk better, let me talk you through my sailboat analogy.
I am an inexperienced fair weather sailor. I would only sail close to shore and in calm weather. Few days of the year would be calm enough for me and at the first sign of rough weather, I would head for the harbour. With time and experience, I would get more confident and take on more risks, like heading out further to sea and braving poor weather.
An extremely experienced sailor would be relaxed heading out to sea, all year round and would be unfazed by bad weather. They see staying away from the coast and going in a straight line to their destination as far less risky than slowly navigating the coastline. Rough weather and high winds are seen as an opportunity to get to their destination much quicker than in calm conditions.
Investing is no different. The speed in which you want to achieve your investment goals will drive how much risk you need to take. Want to get there quick sticks, you might need more return and hence more risk.
So where do most people come unstuck?
New or inexperienced investors can be gung ho and oblivious to risk. They jump in a boat for the first time today and tomorrow they try to sail to New Zealand. Some are lucky enough to get perfect weather and others hit a major storm (like a COVID-19 pandemic or a GFC) and either their boat sinks or they are so rattled they lose their nerve, race back to shore and never go sailing again.
While experience is the best teacher, not all of us have enough time and cash to be able to learn the required investment lessons. Nothing beats having an experienced adviser (sailor) on your team (boat) to give you the confidence to learn how to invest (sail) properly, to let you know when you need to stay the course or when to head back into shore.
But the best ones can help make sure your boat (investments) is seaworthy, so that at the first sign of rough weather, it doesn't sink to the bottom of the ocean, with you in it.
- Ben is an authorised representative of Charter Financial Planning. This article offers general advice only. You should seek advice tailored to your particular circumstances before taking action.