In the second-part of her introductory series on investing women's wealth advisor Sheryl Sutherland looks at risk and return.

By Sheryl Sutherland*

There is an old saying: nothing ventured, nothing gained. Bear in mind that you will need to take some risk to make a profit. If you understand the risks, you won’t get a nasty surprise when you see the value of your investments fall. There is no way that your investments will grow steadily at the same rate all the time.

Think about the fluctuations you see in mortgage rates, for example, or in bank interest rates. No return or rate is immutably fixed. The most important thing to understand is the type of risk you may face in the course of investing. Risk is too complex to measure by any one standard. There is the risk of your investment not earning as much in one place as another, or earning less than you anticipated.

Management risk exists because of the way a company or government performs. Your investments can be subject to currency risk. Values will fluctuate according to the value of the New Zealand dollar. Geopolitical events will affect your portfolio: the threat of war, or acts of terrorism, or threatened epidemics may all affect prices.

Political risk is also a strong factor. A change of government or political instability usually has the effect of driving markets down. Market risk is the risk of the market as a whole being depressed. This is known as a bear market. I have experienced at least eight bear markets, of varying lengths – they are a great time to buy.

Even investments like bonds are vulnerable to risk. If interest rates go up when you have an investment at a lower rate than that offered by the market, the value of your bond will decline. Usually higher rates are linked to inflation, which means also that the money you are earning on these investments will buy less.

Don't get discouraged

Now don’t get too depressed by all this, because the level of risk you take is related to your time-frame. Generally the longer the time-frame, the lower the risk. Perceptions of time frames vary according to the individual – some people view six months as long-term. In the financial world, time-frames are roughly as follows: short-term – eighteen months to three years, medium-term – three to five years, long-term – five to seven years.

The value of a high-risk investment lies in the fact that it is associated with higher returns. Levels of risk are different depending on the type of investment; cash has a very low risk, while shares or property have a higher level of risk, in the short term, with shares out-performing other asset classes in the long term – see the following graph.

Liquidity

Liquidity refers to the ability an investor has to realise funds within a short time-frame. Most investments can be realised in the case of an emergency, but it is wise to consider having at least some of your funds in a cash deposit or a cash management fund – more on this later. Property, for example, is highly illiquid: you have to sell it to release your equity (the portion the bank doesn’t own). In the case of shares, they can certainly be sold quickly (at market) if necessary, but you will have to take whatever price is offered.

Time-frames and Risk

The level of risk or volatility of an investment is linked to the investing time-frame. The longer the time-frame, the lower the risk you are taking. The following table gives a guide to investment sectors. This will help you select the time-frame and asset class suitable to your investment goals.

Market Timing and Cycles

Getting to grips with the cycle of economic activity is vitally important, given its close relationship to the markets’ movements. This relates to investing your money so you can make a profit, which you can then spend – or some of it, anyhow. These days the media, both print and broadcasting, report the most minute of market movements with great enthusiasm.

‘The markets are up’, they trumpet; ‘the markets are down’, they bellow. This engenders a very short-term view and the volatility can be daunting to some investors – but not to women because, and say this out loud, ‘we understand cycles!’

Waiting for the right time to invest is a nonsense – it’s a bit like the right time to be married – hard to establish. Remember the old truism ‘She who hesitates is lost!’ There is another factor that we need to acknowledge when we invest. It’s the roller-coaster of emotion. Emotion is a major dynamic in making investment decisions, which is only now beginning to attract the attention of some commentators.

Typically we treat our financial decisions when investing quite differently to any other purchase. We want to buy when markets are at their most expensive, when profits are up. This is when we are at our most optimistic, rather than when they look miserable and we are at our most pessimistic. Baron Rothschild said ‘Buy when blood is running in the streets’; a fairly graphic description, but nonetheless true.

There are plenty of opportunities, for those who aren’t able to step off the emotional roller-coaster, to make costly decisions. An obvious point is at a market peak, the hapless investor who jumps on at that point is in line for a great downhill ride – a bit like skiing down a steep slope without the ability to do anything but fall over (or sell).

Usually this is done right on the point of maximum opportunity when hapless should be riding the rollercoaster all the way up again. It would be fair to say that I’ve seen more investment decisions based on emotions rather than on logic, facts and reason.

*Sheryl Sutherland is director of Christchurch-based Women's Financial Strategies and author of Smart Money and Girls Just Want to Have Funds.