Risk, reward and rainforests
We always make sure that investment recommendations are made with reference to a preferred level of investment risk, reward and volatility. The three are closely connected.
It is impossible to break the link between investment risk and investment reward. If you take less risk, you have to accept that you will receive lower rewards. Conversely, if you want a higher return from your money you have to accept a greater degree of risk and volatility.
Investment theory tells us there is an ‘efficient frontier’; effectively a glass ceiling which cannot be broken when investing money. It is a graphical representation of risk and reward, and something we always use when making recommendations to our clients, as a way of showing them the current position of their portfolio compared to where they should be.
Very often we find new clients are investing money in a very inefficient manner. This means they are taking more risk than they need to be taking for the likely reward they will get. When we plot existing pension or investment portfolios on the efficient frontier graph and discover they are positioned below the efficient frontier line, this tells us that the investor could either take less risk or get better rewards for the risk they are already taking.
We know that the link between risk and reward is unbreakable and every investment theory proves this to be the case. Unfortunately it does not stop some investment providers from trying to break the link or some investors from believing they can get higher returns with lower risk. There is always a price to pay when this happens.
A good example is the recent collapse of Keydata, a provider of structured investment products. These are still widely promoted investment products, often sold by the banks, where it is claimed that your capital is safe but you have the prospect for high returns usually linked to a stockmarket index or indices. Some recent high profile failures of this type of structured product should teach investors a valuable lesson about risk and reward.
You might be wondering about the relevance of rainforests to all of this. When Keydata investors starting digging deeper to find out precisely where their money was invested, the trail appears to lead to a large expanse of the Amazon rainforest. It has been claimed that 800,000 acres of rainforest were purchased in Brazil with assets from this investment product.
This leads us to another important investment lesson; never invest your money unless you know precisely where it is being invested. Ask your adviser to take the time to explain to you, in as much detail as you need, how your pension and investment funds are being invested and what level of risk you are taking with your money. It is your money and you deserve to know the answers to both questions.