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JIMMY MOYAHA: Paul Nixon, head of behavioural finance at Momentum Investments, has the view that risk is good. We know that we’ve been in a very weird kind of risk environment with risk-on risk-off approaches not really making sense and being controlled in large part by the central banks. But Paul, thanks so much for your time this morning. What risk is good risk?
PAUL NIXON: Good morning, Jimmy, and good morning to all the listeners. That’s a good question. If we think about it, to most investors risk is all about the chance of losing money, coming out with less than what you put in. If we have a think about what kind of factors could impact that, you can probably pull it apart into three or four key features.
There’s the risk that we’re comfortable taking; that’s a psychological function. Some of us are just better at handling risk than others. That’s kind of part of our personality. Then there is the risk that we are able to take. That’s an income statement and balance sheet thing. If we have an emergency fund, for example, we can take a little more risk.
If we don’t have it and we’re forced to dip into a market-linked investment to cover an emergency, that could be a big problem. Then this is the risk that we need to take.
I think when we say risk is good sometimes, we need to understand that if we don’t take risk, there is also a risk that we’re not going to reach our goals – especially if they are long-term goals – because we have things like inflation that we need to account for.
Those are the three main pillars.
And then in the middle, which is probably one of the most important ones, [there is] how risk is going to make us feel. That’s our risk perception.
Markets are going up or down and we’re feeling different amounts of risk in the markets, and this often convinces us that it’s a good thing to dip into our investments and try to get to what we think is safety, but it often results in what I call a behaviour tax.
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JIMMY MOYAHA: Now Paul, with great power comes great responsibility; but with great risk comes great reward, right?
PAUL NIXON: Not necessarily. If you go to financial market theory, I think what investors often forget [is that] taking more risk does not equal more reward; it equals the opportunity for more reward, which means that there are going to be variable outcomes.
So taking more risk in your portfolio is necessary. If we look at financial physics, for example, you need to be putting money in things like stocks and property over the long term because those investments have the characteristic that they’re able to pass over price increases to consumers. So they’re good inflation hedges.
Over the long term they’re likely to give you a better return than inflation. But that doesn’t necessarily mean that we’re always going to get a good return. That’s where investors miss, and that’s that risk perception I was talking about – the feeling of how risk is going to feel along the journey is so important and where a lot of investors make a lot of mistakes. So taking risk is important.
We’ve got to remember that part of financial physics is that taking risk does not guarantee us return.
Over the long term there are a lot of statistics that would say that we will get an inflation-adjusted return, but at any one given point in time that could be different.
JIMMY MOYAHA: So then how do I balance the two? How do I get the right level of risk exposure without compromising the psychological side of it, and what does that look like? Do I get a financial advisor? How do you structure that?
PAUL NIXON: I think the discussion we’ve had now and the four components we’ve talked about already allude to the fact that, hang on a second, this is actually not that easy. So there are four factors that need to be balanced. It doesn’t help if you’re going to have a very short time horizon.
For example, it doesn’t matter how much risk you like or how much risk you’re comfortable taking, you probably shouldn’t be taking it because markets are going to be going up or down.
So if you have a shorter time horizon, sort of under three years, you probably don’t want to be investing in risky assets because the chance is when your goal actually comes in three years’ time markets may be down – which means that you may withdraw when markets are down.
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So there’s time horizon related risk, there’s risk [in] your psychology, there’s risk [in] your income statement of balance. Can you afford to take it? And then there’s the advisor that kind of manages this process for you. So it’s not as easy as it sounds.
I think that’s where a lot of investors fall short as well. They sort of go straight into investing in markets without these kind of basic building blocks in place, and without the right help to make sure that they understand these building blocks and that they can actually sort of weather the investment journey.
So an advisor is going to play a very important role in helping you to actually stay invested.
During the Covid crash in March 2020, for example, we saw about R650 million lost in behaviour tax, simply because people were pulling money or moving towards the cash side of the risk spectrum in March 2020.
Then markets recovered within three months. A year or two later we were breaking records and people were struggling to get back in. So don’t tie markets. It’s not possible. No one knows what’s going to happen.
Warren Buffett doesn’t know, no one knows. What you need to do is stick to the golden rule: if your investment goals are not changing, your strategy to reach those goals shouldn’t be changing either. So take your eye off the daily and weekly market movements.
JIMMY MOYAHA: Get your building blocks right, and let the market do the rest. That’s how you navigate risk.
Thanks very much, Paul. That was Paul Nixon, head of behavioural finance at Momentum Investments.
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