Many investors don’t understand risk until it’s too late. CEO & Founder Mike Taylor explains diversification and why you don’t want your investments to leave you feeling anxious.
There is a saying that if you are going to put all your eggs in one basket, you need to be sure to watch that basket. But most of us don’t have the time to watch the basket 24/7, the requisite skill required to spot threats to our basket. The main example we come across at Pie is where investors have all their money in just one of our funds. I see this all the time and I have witnessed over the last decade investors become stressed out if the fund they are in underperforms for a period. This is incredibly frustrating to watch, because a simple solution is to diversify across our product range.
Covid gave investors an example of how your investment will behave during times of extreme stress. If your investment didn’t pass the sleep at night test, then perhaps it’s time to reconsider the risk you are taking. No investments are worth losing sleep over. It’s important your investments don’t make you feel very anxious or worried.
Risk versus return
At university, finance students are taught the benefits of investment diversification and American economist Harry Markowitz’s modern portfolio theory is drummed into you. The theory assumes that investors will construct a portfolio to deliver the minimum level of risk for an expected return. Maximise return, minimise risk. But we still see investors every day focusing on maximising return, without considering risk. For example, in a portfolio of stocks, about 20 positions (across different locations and sectors) provides the optimal level of diversification. After that, the benefits of diversification diminish rapidly.
How do you check?
Most investors don’t understand risk until it’s too late. Or as Warren Buffett might say, you don’t know who is swimming naked until the tide goes out. The best way to measure risk is volatility. The higher the volatility, the higher the return so the saying goes. Lower-risk funds tend to have lower returns and lower volatility.
It is easy to check the level of risk for the type of investments you have. All financial products in New Zealand, including your KiwiSaver, have a Product Disclosure Statement (PDS) which lists the risk levels, in line with the FMA’s risk framework guidelines. These range from 1-7 (1 being low, 7 being high risk).
For Pie’s funds, you can view the risk indicators in the Product Disclosure Statement or the latest quarterly fund updates. For example, the Pie Australasian Growth 2 Fund is a 6 and the Conservative Fund a 3. Term deposits are a 1.
Diversification should be across asset classes (property, shares etc), across regions (NZ to Europe etc, and no, Australia doesn’t count!), and across sectors (IT to travel etc). Pie has a range of funds that can help diversify your portfolio because our funds focus on different regions, and we have funds that invest in different asset classes.
Depending on how much you are looking to invest, Pie’s financial advisers can help you with tailored advice on your portfolio structure.
Diversifying your money and investments across a wide range of asset classes and risk levels can help reduce the risk that can come with investing.
Information is current as at June 2021. Pie Funds Management Limited is the manager of the funds in the Pie Funds Management Scheme. Any advice is given by Pie Funds Management Limited and is general only. Our advice relates only to the specific financial products mentioned and does not account for personal circumstances or financial goals. Please see a financial adviser for tailored advice. You may have to pay product or other fees, like brokerage, if you act on any advice. As manager of the Pie Funds Management Scheme investment funds, we receive fees determined by your balance and we benefit financially if you invest in our products. We manage this conflict of interest via an internal compliance framework designed to help us meet our duties to you. For information about how we can help you, our duties and complaint process and how disputes can be resolved, or to see our product disclosure statement, please visit www.piefunds.co.nz. Please let us know if you would like a hard copy of this disclosure information. Past performance is not a guarantee of future returns. Returns can be negative as well as positive and returns over different periods may vary.