Are you a conservative investor? If you think about it, it's human nature to avoid risk. From an investment perspective, I find most investors I meet prefer to err on the side of being conservative. They all want higher returns with less risk. Is this possible?
Conservative investing is kind of trendy.
For the past 12 years, we have seen a number of significant downturns in the stock market. The big bad bear market of 2001/2002, started this trend towards conservative investing and then the financial crisis in 2008 was the icing on the cake, especially for the aging baby boomers heading closer and closer to retirement. One would expect that this aging demographic would naturally become adverse to risk. Why then are so many conservative investors feeling the sting of the market?
Low interest rates = managed money
Let's look at a few possible reasons why portfolios are getting riskier, not more conservative.
Firstly, low interest rates are partly to blame. At one time, you could invest in a GIC and earn healthy double-digit returns guaranteed with no risk. Today, guaranteed investing is not very attractive given GIC rates between 1% and 3%. Many investors are looking for alternatives like mutual funds and stock markets to earn higher rates of return but ultimately that means more risk in their portfolios.
Secondly, many financial advisors and institutions are geared to providing investment solutions using some form of managed portfolios. It's not easy finding staunch supporters of the good old-fashioned GIC these days.
Thirdly, there is a big disconnect when it comes to defining and understanding risk between the investor and the industry. The industry looks at risk on relative terms. For example, a fund manager can lose money but if it is less than the average or a relative benchmark, it's not too bad. Investors, on the other hand feel that losing money is not a good deal no matter what you compare it to.
Related article: Different Ways to Measure Risk
What is conservative investing?
The biggest problem as I see it is there is no universal definition for what conservative means. If you think about it, conservative investing for a 75 year old is likely to mean something different than conservative for a 45 year old. I think the word conservative is over used and abused. And given these volatile markets, more and more people are likely to jump on the conservative bandwagon.
The reason it is so hard to define conservative is simply that conservative is merely a feeling that comes from the stomach and the heart. Not only will different people define conservative differently, but we all change how we feel about investing on a regular basis.
It's time to define conservative investing differently. It's time to try to quantify risk. Here's two tips on how to better quantify risk.
- What is the most you can afford to lose? In technical terms, we call this downside risk management. In the non-guaranteed world, you may lose some money at some point in time. What is your comfort zone? 5%, 10%, 20% or more. Most conservative investors would prefer to minimize losses but what's your threshold?
- How often can you deal with loss? If you think about it, the last bear market we had happened in 2008. That was about 6 years ago, which is a normal time frame for cycles to occur. Determining an investments chance of loss means understanding how often an investment has lost money versus making money in the past.
Related article: How much money can you stand to lose?
Most of us agree that understanding risk is very important to the investment process. Rather than generalize risk with generic terms like conservative and aggressive, it's time to look at risk in greater detail. Conservative investors need to take the time to understand risk, find ways to quantify risk and then select appropriate investments. Any investor that takes the time to go through these steps will be more comfortable with the investment choices they make.