August 28,2015

Beyond Volatility – the Risk of a ‘Low-Risk’ Investment Strategy

Risk and Volatility.  These topics have been coming up frequently in discussion this week – a meltdown in the global equity markets will cause such things to happen.  China’s benchmark index declined 8.5% in one day.  Any and all gains that had accrued this year were wiped out during this decline, and (at the time this is being written) the index now finds itself down 38% since the apex in June. The ripples are being felt around the globe as world stock and commodity markets also tumbled in the wake.  This is not the first time in history we have seen equity markets fall at significant levels in such a short period of time, and it most definitely will not be the last.

The potential for negative returns = a Risk of Investing

For most investors, this is the easiest form of risk to conceptualize as we are all familiar with the concept of negative rates of return after market volatility.  Some investors define risk only as the potential to ‘lose money’ when their investments take a tumble.   (‘Losing money’ is technically not the correct term assuming funds are still invested, but that is a topic for another time.  As is the concept of ‘buying opportunity’ after steady declines) For this reason alone, many investors turn to a conservative or risk-averse investment strategy.  Afraid of potentially ‘losing their money’ in the markets they turn to GICs.  Term Deposits. Cash.  If they are feeling adventurous, maybe a low risk bond fund will be added.  These safe investments will spare investors from seeing negative returns when they receive their annual statements.  Do not be fooled though – there are definitely risks associated with a long-term/low-risk investment strategy.  Over time, this less obvious form of risk can be more detrimental to the investors long-term financial viability than the market volatility itself.

There is more to risk than just volatility and market declines.

Rates of return that do not keep up with inflation is a significant risk.

Outliving your savings is a risk.

The concept of outliving your savings or not falling behind inflation has been a frequent topic of discussion when we meet with employees to discuss their retirement plan and retirement planning basics.

If we are saving for retirement, and have a mid-to-long term time horizon, accepting short-term market volatility risks in favour of long-term appreciation will allow your savings to stay ahead of inflation.  Assets that appreciate more over time will also lower the risk of outliving your savings.

Of course, your comfort levels during volatile markets such as these may be tested, but that’s why it is imperative to complete a risk/tolerance questionnaire.  This will allow you to understand your investment style, to create your own investment strategy, and stay on course.

How much do you need, and when do you need it. 

There are many tools available online for plan members when they sign-up for website access to their plans.  There are many professionals that can help you answer these question.  Stragegies can and should be adjusted over time as lifestyle and circumstances change – but decisions should never be dictated by knee-jerk reactions and emotional responses to market conditions like the ones we have seen this week.