For many years I have found the concept of risk fascinating.
In financial planning we often talk about “attitude to risk” but what risk are we having an attitude about? Capital Risk, Inflation Risk, Liquidity Risk, Deep Risk, Shallow Risk, Currency Risk, Risk of not meeting goals? – the list can go on and on.
For me risk is nuanced and can sometimes seems contradictory.
Consider person A who is a business owner. They gave up the security of an employed position and borrowed money to buy an equity share of a business. They also borrowed money to buy an investment property. They have predominantly equities (90+%) in their ISA & Pension portfolios.
Does this person have a high or low attitude to risk?
Compare person A to person B. Person B opts for fixed rate mortgages and budgets monthly. They research well before trying new things and invest in funds which offer the market return less costs (no chance of outperformance there!).
Does this person have a high or low attitude to risk?
Perhaps you are forming a mental image of a risk-taking entrepreneur for person A and a cautious, considered person B.
What if person A and B are in fact the same person? It is true because the person is me.
The truth of it is that we all perceive risk differently and see different risks in different ways.
I do not see equities as risky in the long term hence my high allocation (for me volatility in the stock market is not the same as risk) yet variable rate mortgages to me are (I like security in my monthly budgeting).
So, whilst risk questionnaires are often used to help gauge attitude to investment risk it is important that we understand how we perceive risk. This is what can help us make good financial decisions and also reveal what blind spots we may have.
Over recent years I have lost count of the time people have asked me about the merits of buying an investment property with their cash savings due to low interest rates. The inference being that investment property ownership and deposit-based savings have the same risk characteristics. Nothing could be further from the truth, and I am not saying one is better than the other, I am saying however they are simply different.
If you are interested in the area of behavioural finance and the study of how we make decisions (financial or otherwise) I can highly recommend:
The Behavioural Investor – Daniel Crosby
The Little Book of Behavioral Investing – James Montier
Thinking Fast and Slow – Daniel Kahnemann
The importance of an objective third party when deciding on financial options (which all have some flavour of risk) cannot be underestimated. By definition we cannot see our blind spots – having someone shine a light these could help us make better financial decisions.
Warm regards
Neil
