The probability of losing money in an investment differs according to the investment type, generally speaking. We all have some idea of these differences in investment risk. We know that bank deposits, for example, have a minimal degree of risk. On the other hand, shares in a company can be relatively risky.
If you ranked the various types of investments (and “so-called” investments), they would form a spectrum, from very low risk on the left to very high risk on the right.
On the extreme right would be scams parading as investments. A genuine investment is when your money is used constructively to generate profits from legitimate business activity. A scam is simply a non-violent way in which a crook can part you from your money; there is no intention to use the money to generate growth. Usually, the touted rates of return are unrealistically high to lure the greedy.
In a Ponzi scheme, an elaborate form of scam, the “returns” of the initial investors are funded by the capital of new investors. While the early investors may make a killing, the majority lose their money. Ponzi schemes sometimes start off as legitimate investments but devolve into scams when things go awry. Examples are Bernie Madoff’s notorious hedge fund in the United States and Barry Tannenbaum’s medicine-importing scheme here in South Africa.
To the left of scams, but still at the far right of the risk spectrum, are unregulated investments. These include property syndications, shares or debentures in private (unlisted) companies, venture capital schemes, and offshore investment funds in jurisdictions with relatively lax financial controls. They are mostly legitimate, but sometimes only border-line so, and sometimes they’re downright dodgy. Furthermore, there are few regulatory controls in place to protect you.
If one of these investments is offered to you, do as much research as you can on the business/scheme/fund before committing your money, and then only money you can afford to lose. If you are looking for an investment for your life savings, stay well away, no matter how enticing the proposed returns or how convincing the salesperson.
Moving further left on the risk spectrum, we enter the more familiar territory of regulated investments. These are legitimate savings vehicles and investments that are regulated by the Financial Services Board or the Reserve Bank. They can be subdivided into direct investments – where you invest directly in assets or debt instruments, such as listed shares, government and corporate bonds, and bank deposits – and collective investments, such as unit trust funds, exchange traded funds and endowment policies, in which investors’ money is pooled in an investment portfolio.
These may be less risky than unregulated investments and you may be more protected through legislation such as the Collective Investment Schemes Control Act. But don’t be under any illusions: there are still major risks attached to many of them.
How can you lose money in a regulated investment? Here are some of the ways:
- Bank deposits are not entirely risk-free. Although the chances are low, the bank could go under, taking your savings with it.
- If you are invested in assets such as shares, bonds or property, the values of those assets are subject to short-term fluctuations and occasional market crashes.
- If you are invested in offshore investments, there is a risk that the rand will strengthen against the relevant foreign currency, losing you money in rand terms.
- If your returns, in whatever you are invested, do not match inflation, you will lose money in real (after-inflation) terms.
Collective investment schemes (unit trust funds and exchange traded funds) are risk-graded according to what they invest in, ranging from low (cash and bonds) to high (equities and listed property).
Broadly speaking, of the equity funds, the general equity funds (those that spread their portfolios over all sectors of the JSE) are lower risk than those that specialise in specific sectors, such as financials, industrials and resources.
Your financial adviser will tell you that, in order to make decent returns over the long term, you need to take on a certain degree of investment risk, and that this risk can be “managed”.
Safe, low-risk investments, such as bank deposits, are appropriate vehicles in which to “park” your money for the short term, but to make inflation-beating returns over the long term (more than five years), you must be at least partly invested in higher-risk “growth” assets, such as equities and listed property. Over time, market ups and downs are smoothed out and you stand to benefit from the “magic of compounding”.
Your adviser will also tell you that a good way to manage risk is through diversification. If your portfolio is diversified – invested across asset classes – you spread your risk, because the market cycles of the different asset classes tend to be “out of sync” with each other – in other words, when one is going down, another may be going up.
So if you are a responsible investor, prepared to take a calculated degree of risk, suppressing your fear of losing money in the hope of making decent returns, and wanting a diversified portfolio that is managed on your behalf by an investment expert, where do you turn?
Thousands of South Africans have turned to multi-asset unit trust funds. These so-called “balanced” funds can invest across asset classes, but have a fair proportion of their portfolio in growth assets, depending on their sub-category (low equity, medium equity, high equity and flexible).
The latest figures from the Association for Savings & Investment SA show that domestic multi-asset funds are the most popular form of unit trust investment among South Africans. They accounted for 51 percent of the more than R2 trillion invested in collective investment schemes at the end of September this year, up from 29 percent five years ago.