Close encounters of the risky kind

Published on www.switzer.com.au on Friday 29 November

Last week we took our Switzer Income Conference to Sydney, Melbourne and Brisbane and over 2,000 people came along to listen to a big number of different fund managers and other investment professionals tell the audience about their respective products.

The first question I asked the different groups in each city was: “Who’d like to be invested in term deposits at 5-6%?” Everyone in the room put their hands up and I understand why, when term deposits are now coming in at less than 2%.

Most retirees would be happy to be fully invested at 5% in a term deposit that’s government guaranteed up to $250,000. Someone with $2 million in super might be happy with a safe 5% to live on $100,000 a year.

Who has got $2 million in super? A couple of teachers, public servants, accountants, lawyers, doctors and successful small business owners could have that amount.

There are many couples and singles with $1 million in super and many of them can live on $50,000 a year but they can’t get it the safe way. As I said at our conference, if you want at least 5% (but most people would love 7% to 8%, given what my financial planning clients seem happy with), then they have to venture up the risk curve.

What does that mean?

This means that they have to invest in stocks, hybrids, bonds or bond funds, mortgage funds and Real Estate Investment Trusts or REITS, as well as property trusts.

All these types of investment products at our conference were paying better than term deposits but I had to remind the audience that while their performances might have been good to great, a recession and stock market crash could find them out.

Many of the presenters showed graphs of their good long-term performance but 2008 and 2009 showed that they experienced some troubled times over the GFC and that has to be taken on board by anyone who decides to go up the risk curve.

Imagine a curve sloping up left to right. On the vertical axis you have return, and risk along the horizontal.

Low on both risk and return is a government bond, closely followed by a bank term deposit. Then follows bond funds, corporate bonds, hybrids and stocks. You can argue what should be above what’s on the risk curve but the bigger the promised return, the bigger the risk.

That was the message I drove home at the conference and it’s why both Paul Rickard and I rammed it home again in our master class on income — when you take on riskier, higher returning products, you have to be diversified.

The old proverb applies “don’t put all your eggs in one basket” and don’t get greedy and chase high returns from one investment product supplier who could come a cropper in the GFC-style event. And let me warn you that they always show up when most people least expect it!

In my book Join the Rich Club (which is on a massive Black Friday sale I just noticed!), I show newcomers to investing that you can buy stocks and expect a 10% per annum return over a decade, where half of that return will be dividends but two or three of those 10 years could be shockers for overall returns. There could be two years when your portfolio of stocks could fall 20% but, over the decade, history says you can make 10% per annum, provided you invest in the kinds of investment products that mimic a good portfolio based on the S&P 500 Index in the USA and/or the S&P/ASX 200 for local stocks.

But because the returns are big, they come with risk. If you can afford to ride out the bad years, the good ones will more than make up for those bad ones.

One of the most important messages in my book is about the need to be diversified into top quality assets. Personally, I’ve designed my super fund to be based on quality, dividend-paying stocks but I roll the dice for some bigger or alpha returns on a small number of more riskier stocks but limit my exposure to make sure the bulk of my super fund delivers.

Warren Buffett once joked “Diversification was for wimps” but if spreading around my investment monies among a basket of good assets of varying risk and returns is for wimps, I’m sure in the fullness of time I won’t end up with egg on my face.

This little reminder will be sent out to all my attendees to the Switzer Income Conference: when you go up that pesky risk curve, make sure you do it in a diversified way.

If this period of very low interest rates makes investors want to read books like mine to become better at investing and to be a diversified investor, then it has been worth it.

Also, if you want to teach yourself and/or your “growing up” kids about investing, Join the Rich Club might be a good Christmas gift. And if it effectively closes your branch of the bank of mum and dad, because it teaches your family withdrawers how to manage money, then it might be the gift that keeps on giving!

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