Financially Speaking Podcast

Before It's Time

Published on June 8, 2012

When I ask investors to define risk, you think it means losing all your money with no chance to recover the funds.  I think risk is the change in the value of your investments at certain intervals of time.  Risk is seen differently based on time.

A recent article by Geoff Davey, CEO of FinaMetrica in Australia, which provides investment advisors client risk measurement tools, illustrates this point.  His article looked at the historical performance over the past 40 years of a portfolio that is invested 70% in stocks.  During that time and based on monthly data, the value of the portfolio fell 33% of the time, recovering 41% of the time and rising 26% of the time.  Therefore someone with that portfolio should expect the investment value to go up 74% of the time and go down 26% of time.

Does a more conservative portfolio-one with only 30% in stocks-provide a smoother ride?   Surprisingly it doesn’t.  The conservative portfolio rises about 66% of the time and falls about 33% of time.  The ride isn’t that much smoother than the more aggressive portfolio.  However the difference is the amount of the falls and rise of the conservative portfolio.

What if we look at the same portfolio for different time frames?  Viewed on a quarterly or semi-annual basis, the portfolio rises more often than on a monthly basis.  On a yearly basis, the more aggressive portfolio rises 92% and falls only 8% of the time!   The more conservative portfolio rises 81% of the time.

I can remember a time when mutual funds sent account statements each calendar quarter and some of them only once a year.  To make any changes in your investment required a phone call or signed letter.   Now you can see the change in value of your portfolio every 15 minutes and you can buy and sell with the push of a computer key.   Management of investor reaction to changing account values in short time intervals is the challenge of investment advisors.  Investors often make portfolio changes after the fall and then miss out of the subsequent rise.

In my view, risk is an investor changing their portfolio before it’s time. 

Tags: investment risk, investor behavior

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