The risk of too little risk

Every investor needs to be cautious with their decisions, but strange as it may sound, there’s also a risk in being too cautious. 

The aim of any investor is to maximise their investment returns while minimising their risk. Of course you want to make money, but you don’t want to take the chance of losing it all, and therein lies the delicate balance. Some investors are risk-averse, in that they’ll do whatever they can (within reason) to reduce their risk. The thinking is pretty simple: you want to know, with as much confidence as possible, that your money is safe and that it will grow. But while that sounds like a sensible approach, you also run the risk of exposing yourself to too little risk.

In an investment context, it is entirely possible to take too little risk. There’s a real danger in doing that, because while risk can mean that you have a greater chance of losing money, the flip-side of that coin is that you might get lower returns than you’re hoping for. To put it simply: if you don’t take enough risk, you might not make enough money over the long term to meet your investment goals.

So let’s say you need an average annual return of 10% in order to meet your financial goal. If you invest in a low-risk portfolio that only offers returns of 7%, you won’t lose money… but you won’t meet your goal either. Now if your goal is to retire comfortably, that lower return could force you to delay your retirement or settle for a lower annual income in retirement.

Understandably, many investors err on the side of caution when it comes to their retirement investments. After all, if that’s all the money you have to live on, you don’t want to risk losing any of it. But that’s exactly why a risk-averse strategy can be even riskier than taking on some investment risk. 

Risk-averse investors often forget that there are solutions to mitigate risk. It’s all about knowing what your risk tolerance is, embracing the power of long-term thinking  and seeking out consistency in your investment portfolio. Speak to your financial adviser and plan accordingly. If you need more information, feel free to contact our Client Services Team on 0860 105 775 or email us at query@prudential.co.za.