Investment complacency is back
Complacency is back. The opposite of risk is no risk, while a complacent attitude falls somewhere in the middle. It is really a matter of doing nothing, which is, in itself, a choice — to take a risk. We tend to regularly soothe ourselves with complacent thoughts, both subconsciously and in the now. Heading to work in the morning, we bop into the car and drive off, never thinking to check those tyres. Why should you?
It is a new car and besides you have never had a problem before. We head to the ATM for some quick day run funds, only to see that we are overdrawn. We never forget to transfer cash, or so we think.
We put off practising preventative medicine with regular health physicals. Why should we get one? We never get sick — until the one time that we become quite ill. We even become complacent after we have had solved problems in the past, because we assume that it won't happen again, or at least, not again during our lifetimes. We have taken care of the problem, we think. If you believe that to be true, then you need to spend time reading Nassim Taleb's book, Fooled by Randomness.
The confluence of overconfidence. We never expected to have our tiny island trying to cope in the global sub-prime recessionary vortex either, because it hadn't happened before — to any degree. Therefore, since it didn't happen, it won't happen because we believe our own confidence.
The thought process then becomes the reality that Bermuda will be immune to this crisis, too. After all, who would have considered that the tourist market, the construction and related rental industry, interest rates and global investment markets would be affected at the same time.
Was it random and completely unpredictable? No. Was it because we did not heed those wise economic forecasts?
What we know is that the most prescient among us saw all the signs and issued warning after warning; we just refused to think (in our overconfidence) it could possibly happen to us.
Can risk be avoided, or is it just dumb luck? The answer is not always known but the science of quantifying risk provides enormous fodder for statistical analysis. What is important to understand is that becoming totally complacent about risk that can affect you personally is an invitation to be torpedoed again.
Where might you ask am I going with this diatribe? Investors are becoming complacent again. They are relaxing as market gurus tell them that the recovery is on its way, sort of. They are getting used to, and expecting to see, outsize returns as many investments bounce back from their low loss values of the last two years.
Their expectations are again exceeding the capability of their pocketbooks and their asset allocations. How soon we forget.
Investor Profile | Rate of Return | Acceptable Loss |
---|---|---|
Ultra-conservative | Zero - 6% | Zero |
Conservative | 1% - 7% | Negative 2% - 3% |
Balanced | 2 - 15% | Negative 2% - 8% |
Growth | 5% - 20% | Negative 5% - 15% |
Aggressive | 15% - 50% | Negative 5% - 25% |
Do you remember the outsize returns of less than ten years ago experienced during the Tech boom? Investors expected to regularly get 80 percent annually (or more) on their investments. What were we thinking? A recipe for complete disaster, and that was precisely what happened.
What could be the swing in rates of return on various investments? We need to know this for three reasons:
1. To understand that if your pension has had a year of 40 percent gains, it also has the capability of losing 45 percent or more in a down market year
2. A swing of 85 percent in a two-year period (from 45 percent loss to a 40 percent gain) is an indication of the volatility of the investments
3. If you are a conservative, moderate or balanced investor, this is a risk profile that you should be very uncomfortable with, rather than elated. This is not how we think, however.
People who have been completely adverse in the past to investment markets, and have always kept their savings in fixed deposits (and other low risk structures) have happily told me that their investments are up 25 percent this year alone.
This is not a reason to feel comfortable, this is a reason to be very careful. What goes up, will move down again in another market downturn at another time. Always ask yourself the question: if I am pleased with a 25 percent increase in my investments over a year, am I just as willing to accept a 25 percent-30 percent loss or more over the same time frame, or even longer?
Most investors when discussing risk tolerance questionnaires have no problem with that loss reference, in theory on paper. When it happens to them in real life, watch for the disbelief and despair!
What ranges of returns should an investor profile feel comfortable with? A composite chart of investor confidence levels culled from actual reactions of clients over the last twenty years reveals some interesting data. We all love getting the great returns, but hate seeing any losses. In fact, my observation has been that the more sophisticated investors willing to take more risk really hate experiencing losses — of any kind.
Risk in capital markets is with us always. It is the risk that is beyond our control on a systemic basis. What we can control (somewhat) is the amount of risk that we want to accept and our perception of what that risk represents — in both good and bad market.
Now is the time to review your individual personal investments and your pension allocations. Find your comfort zone and stay with it. There, you've taken one stressor off your very full life plate.
Reference: Determining Risk And The Risk Pyramid by Investopedia Staff, (Investopedia.com)
Martha Harris Myron, CPA, CFP (US) TEP (UK) JP- Bermuda is an international Certified Financial Planner practitioner. She specialises in independent fee-only cross-border tax, estate, investment, and strategic retirement planning services for Bermuda residents with cross-border and multi-national connections, internationally mobile people and US citizens living abroad. For more information, contact martha.myrongmail.com or 735-4720.