According to its prospectus, Public Asia Ittikal Fund, the latest fund from Public Mutual is aimed at “aggressive” investors who are seeking capital growth over at least the mid-term (minimum of 3 years). In other words, PAIF is not for pussycats! Or so it would appear.

People usually get scared off when they hear the word “aggressive”. Visions of Rambo and Arnold (aka the Terminator) are very much at odds with the “metro-sexual” New Age aware society we live in today. And when the term “aggressive” is bandied about in the context of investing our hard-earned money, we get even more spooked

So then you might start to think, maybe it’s only the super-rich or the get-rich quick types who invest in the stock market and mutual funds….Not so!

The concept of “risk” in investment has to do with volatility or how widely the price of a stock or mutual fund fluctuates. The wider the fluctuations, the higher the risk. This is because you stand to make and also lose more money, compared to a fund that doesn’t fluctuate as wildly.

Following on from this investment concept, “aggressive” or “high risk” means that a mutual fund or stock can potentially achieve higher returns because of greater volatility. In contrast, “low risk” or “conservative” means that a stock or mutual fund will trade close to its historical average prices and will tend to be quite stable.

More volatile or high risk mutual funds are usually characterized by holdings of a greater % of the overall investment portfolio in stocks or equities. The opposite is true for less volatile or lower risk mutual funds – these generally hold more fixed income instruments like bonds, debt securities and the money market.

Over time, mutual funds that hold more equities will tend to outperform funds that invest mainly in fixed income (i.e. interest-bearing) instruments, just as equities will tend to outperform bonds, debt securities or fixed deposits. This is why we say “risk and return go together”.

How much risk (return) should you take?

Since there is a trade-off between risk and return, you can’t just say, “I want the highest return (eg. 10-15%) but with zero or no risk”. However typically, many investors think that way. And when forced to choose, they will say “I want capital guaranteed!”. As if there is no middle ground!!

The middle ground

The middle ground is this: higher returns and an acceptable level of risk. For us the investor, the starting point should be to work out what are our key objectives or priorities in investing, whether for retirement planning, deposit for a new house, child’s education etc

Knowing our investment objectives will help us to determine the time horizon for our investment portfolio i.e. how long we have to ahieve our objective. In theory, I would interpret a time frame of 5-10 years to mean that the investor has a moderate to high ability to take risk, whereas a time frame of more than 10-15 years means the investor can be even more aggressive. 

The investor’s time frame to invest is a key element to determining the investor’s risk profile. Other elements that help to determine your risk profile include:

  • your net worth i.e. high net worth generally means you can take more risk. If you’re worth RM5 million, then you should have no problems investing RM50K (1%) of your wealth in an aggressive risk fund
  • stable, and high income means you should be able to take more risk – I suppose doctors and lawyers would generally fall into this category. Too bad I’m neither 🙂
  • investing IQ – if you are a savvy investor, then generally you won’t get as affected when the market fluctuates (after all it’s the volatility that brings the chance of higher returns) so you’re more risk tolerant
  • your need for liquidity – if you may have a sudden liquidity crunch eg. business-owners every now and then, then best not to go for high risk in case you need to liquidate fast 
  • your personality – if you get sleepless nights everytime the market fluctuates, then your risk tolerance is low

Once you’ve worked out your objectives, time horizon and risk profile, it’s time to figure out the appropriate asset allocation for yourself. Asset allocation is just a fancy way of saying that you should diversify your investment portfolio into different asset classes like stocks, mutual funds, property, cash and other liquid assets.

You see, through diversification what we’re trying to do is to spread your risk around so that if one asset class under-performs there may be other asset classes that do well and  compensate for the under-performing asset class. The trick is to find asset classes that have a low correlation or negative correlation with each other, eg. buying equities in different countries may help you to lower your country and currency risk.

In conclusion, if you’re investing for your retirement and have a reasonable time frame to do so, then there’s really no need to be scared of volatility or “risk”, provided you have done some asset allocation and monitor your portfolio at least once every six months. You may even consider allocating 5-10% of your investment portfolio into something more aggressive….it all depends on your circumstances.

This is one of the areas where financial planners can assist. I will be attending a course on asset allocation shortly, as part of my CFP continuing education programme. Will post any bits of wisdom that I get from this very soon. Until then…