Thought the training over the last few months, there has been a lot of time spent on the relationship of Risk versus Reward of investing, and how it relates to clients.  It is the heart of the suitability section of both the Life Insurance and Mutual Funds courses.  Insurance deals with Risk in the form of how likely is it that the insurance company will have to pay out a claim?  Are people in this occupation at higher risk of getting injured or getting a disease than this occupation.

With Mutual Funds, the Risk applies to how does the client feel about seeing their investments increase and decrease.  It also applies to the type of investment.  Money Markets are far less “Risky” than Equities (stocks).  In Mutual Funds, risk is also a function of the investment experience of the client.  Have they just had GICs and Savings accounts, or have they invested in individual stocks?

In my life experience, risk is a part of everything.  Even coming down the stairs in sock feet, instead of slippers, for breakfast is risky.  (Yes, I have slipped on the stairs) Even crossing the street is risky.  With just about everything having a risk factor, why even get out of bed?  Because you have to get things done, and we have learned how to minimize Risk.  We don’t just blindly walk out into the street. We stop, we look both ways, we don’t wear earbuds, we walk not run.  All the things we were taught before kindergarten.  Too bad we don’t get the same training for Financial risks.

I spoke to a lady sitting beside me at a slot machine in the local casino.  She was playing the max bet each spin. (proper gaming philosophy says this is the right way to play.) I go to the casino for cheap dinners, and to keep an eye on my investment.  I own shares in the casino company.  I watched her feed a continuous stream of $20.00 bills into the machine.  I asked her how she felt about investing.  Her answer was no surprise.  She would never invest.  That was far too risky.  I was happy and disturbed at the same time.  I was happy that she was contributing to the profitability of my investment, but disturbed for her financial well being.

There is absolutely no player control over when and how much a slot machine will pay out!!!  You do have some control over the payout of your investments.  So, why do people go and spend a couple of hundred dollars in the casino, but will not put $100.00 a month into a Mutual Fund?  The casino is more fun.

 

As the Chart shows, there is a direct correlation between Risk and Return potential.  When it comes to investing, the greater the risk, the greater the chances of making more money.  Investments are grouped into risk categories by their Deviation.  Deviation means how big is the difference between what they go up and what they go down.  Money Markets deviate very little.  Specialty Investments deviate over a very wide range.

But just like crossing the street, there are ways to minimize risk when it comes to investing.  From choosing the type of investment to learning more about investing.  What would be a reasonable progression from low return, low risk, to higher return, higher risk investments as someone’s experience grows?  We would start with the safest and lowest return which is the standard Savings account.  Very safe and very low return, with interest paid yearly.  Next would be the high interest Savings account with interest paid monthly.  In that account the compounding rule starts to play in your favor. From there we go to GIC’s (Guaranteed Investment Certificates).  All of these are available at any Bank or Credit Union.

From there we get into higher return and higher risk products.  Products with larger deviation. These you can get from banks, investment companies, or buy yourself on the markets. TSX, Venture, Securities Exchange, NYSX, OTC, just to name a few.  Here you can choose either professionally managed investments (Mutual Funds) or Self-Directed investments where you make all the decisions.  The least risky way to buy these is to use Mutual Funds.  Mutual Funds do an excellent job of diversifying your investments to minimize the ups and downs.  They are also managed by people who understand investing and markets.  That does not mean that you can’t do the same by yourself, but it takes far more money, time, and knowledge to do so.  As other articles and posts on this site point out, I do not recommend being self-directed without at least a year or two of investing like its real with using no money.

Watching what underlying investments your Mutual Fund manager selects, can give you a lot of investment experience from a professional money manager.

The courses teach that risk has a lot to do with age.  I think it has more to do with Age and the amount in the investment.  If your 60 and have $500,000.00 in an investment, that is supposed to fund your retirement in 5 years, you definitely want safety of principle and monthly income.  If your 25 and have $5,000.00 in your investment, you can definitely have some of it in more aggressive (risky) investments.  You have time for corrections.  The tricky part is when your 47 and have $50,000.00 in your investments and want to retire at 65 with little or no pension.

That was a scenario that never came up in any of the courses.  That was the scenario I found myself in.  Here the question is, how do I adjust my risk tolerance to suit what it takes to boost my investment.  Even a 10% compounded return for 18 years is not going to be enough.  ($50,000.00 at 10% for 18 years is $278,000.00).  The solution appears simple, save more money.  The reality is, you have bills to pay, so saving more, may not be realistic.

Risk and Return are very important to understand when it comes to investing.   You need to have your investments working as hard for you as you do for them, but you still have to be able to sleep at night.  The definition of “RISK” is not simple when it comes to investing.  It depends on many different factors, and is different for everybody and every situation.