Diana Clement: Whats your tolerance to risk?

How did you feel the last time your KiwiSaver balance dropped? The human brain likes to treat investment losses a bit like childbirth. You never remember how bad it was until it comes around again.

Some people have a high-risk tolerance and might still sleep soundly when their investments take a tumble. For others, a dramatic drop in the market value of their investments such as happened in 1987, 2008, and even the short-lived dip in March 2020, can push them over the edge.

That “edge” isn’t just financial. Low-risk tolerance combined with investment losses can for some people lead to depression, family violence, and even suicide.

Financial adviser Murray Weatherston of Financial Focus remembers the “guy from across the road” who was the high life before the 1987 stock market crash. The guy had built up $3 million in investments in what we know now to be dodgy companies such as Equiticorp.

Come the 1987 crash, $3m man lost the lot. A few months later the man looked so haggard he was barely recognisable.

Weatherston always asks clients how they felt last time their KiwiSaver balance fell to get them thinking. The answer is telling, he says.

Feeling worried when your investment balances fall dramatically is natural. It’s how you coped with that experience that matters. If you panicked, then you were most likely investing beyond your risk tolerance.

Research by the Financial Markets Authority (FMA) found that thousands of young New Zealanders switched out of growth funds during the turmoil of March 2020, with more than 70 per cent of those switches being to more conservative funds.

One young New Zealander, “Ana”, told researchers: “I got scared because I didn’t understand how KiwiSaver really works, so I thought I had lost a whole bunch of money and I would never get it back so then I switched immediately to conservative to keep the money that I had and hopefully not lose any more.”

By doing so she locked in the losses. If she’d understood her own investing style and how the markets work, it’s most likely she wouldn’t have lost a cent.

Some investors never invest again after an experience like the 1987 crash or global financial crisis. Yet such crises come around every decade or so.

“I’m sure a lot of the population would be very surprised know that at least twice in the last 21 years, the equity (share) market has fallen over 50 per cent,” says Weatherston.

Financial self-awareness starts with understanding your own risk tolerance. If you have a financial adviser, you should be given a thorough risk-tolerance exercise. Most of the KiwiSaver providers have risk-tolerance tests on their websites, although some ask too few questions to be useful.

No matter how rock solid your ability to tolerate volatility, ask yourself what could be the worst that could happen to your finances with your current strategy.

Whether it’s $3m man and his “corp” investments that turned out to be corpses, or 21st-century crypto investments, there will always be someone who loses the lot when the tide turns. They won’t see it coming because they haven’t considered the risk.

The more you educate yourself the less likely you are to be caught out by a 1987, 2008 or 2020-style financial disaster. Start with websites such as Sorted.org.nz, FMA.govt.nz and many others.

Be very wary of learning through social media and watch out for what the FMA calls “finfluencers”. Some of these social media influencers who post about finances are paid to promote high-risk investments such as cryptocurrency and derivatives and may not know what could go wrong.

That’s not to say you can’t have a bit of fun with higher-risk investments through Sharesies or on the crypto markets if you’re learning along the way. If you’re borrowing to invest or betting your financial future on it, then consider unwinding your position.

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