Tuesday, March 4, 2008

Taking Risk or "Not" Taking Risk

I had mentioned in my previous postings that Singaporeans are living in an environment of gambling and speculuations. They are not living in an environment of guided Investment.

Human by nature are risk averse and greedy at the same time. They overestimate returns and underestimate risk when they are greedy. They underestimate returns and overestimate risk when they are risk averse.

How they preceive greed and aversity depends on the investment climate. Greedy when market is up. Risk Averse when market is down. (Though should be the other way round as Warren Buffet advised)

Today, I like to write about 3 principles for you to ponder about if you like to invest:

1) Is it necessary to take risk?
a) What is your returns required to meet your objective?
b) If 4% yearly returns are required, why should you be greedy and go for 8% which translate to unnecessary risk?

2) Do you have the ability to take risk?
a) What is your time horizon? When you need this money?
b) Do you need the liquidity? Is your cashflow regular?
c) What is your age and are you in good health?

3) What is your willingness to take risk?
a) You can use a risk profiler to understand how you preceive risk
b) Some people simply cannot sleep well when the market comes down. Everyone is different in this aspect.


As a Financial Planner, we need to guide our clients through the process on how much risk they "need" to take. We should not be guided on how much risk they "want" to take.

Give you 3 typical examples on why some people need to be guided through the 3 principles:

1) Mr Tan, age 58, need $1million for retirement in 4 years. He currently has $950,000. He wants to buy a property costing him $1.2 million because he feel property prices may go up.
* Needs - He don't need to take such high risk because he is near his objective amount
* Ability - He is near retirement, cashflow decrease and liquity needs increase
* Willingness - Though, he wants and willing to take risk, he don't have the need and ability.

2) John, age 12, average student, exam coming, but want to watch TV
* Needs - He need to study because his exam coming
* Ability - He is only an average student so must study
* Willingness - Not willing to study. So we must counsel him that he "Need" to study

3) Michael, age 45, needs $1million for retirement at age 55, now no savings, earns $2k/month
* Needs - He have an objective, but is the objective realistic for his current ability? He needs to relook on his objective.
* Ability - How much can be invest with current income. Small investment need high risk to hit objective
* Willingness - Even if he is willing, we have to counsel on his ability. Excessive risk is as good as gambling.
The 3 principles sounds simple but unfortunately, Singaporeans are generally guided by greed and risk aversity, not by the correct investment principles.

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