Guaranteed returns or guaranteed losses?

It seems trite to be talking about investment returns in the context of the “feesmustfall” campaign however, there are people who still need to invest and grow their money and in some ways life goes on.

One of the more frequent conversations we are currently having is around the issue of market volatility – which to some investors is apparently a new thing. It is in this context (and on the back of 7-8 years of really good returns) that investors often lose sight of the big picture. Market volatility causes panic and they start talking about not wanting to take any risk on their investments. Inevitably their focus turns to issue of “guaranteed” returns.

One such example is of an investor who is looking for income and has decided that the best way to secure his income is by way of a 5 year term certain annuity. In short he will receive an escalating income for 5 years and is guaranteed to receive his full capital in 5 years time. He is over the moon…but should not be.

His income may be secure but he is also guaranteeing himself a capital loss. What he is failing to take into account is that while he may receive his capital back (in nominal terms) in 5 years, in real terms he will be poorer by ±26% – or in his case, R1m on R3.8 million. This is because he has failed to factor in inflation risk! He has forgone volatility risk in favour of a much more dangerous and insidious risk in the form of inflation.

Volatility is a short term investment risk and is just one form of investment risk. Exposing your investments to this kind of risk is the only way to deal with inflation risk. But it requires time to work…1, 3 or even 12 months is not “time”. It takes years…

Inflation risk, on the other hand, is a long term investment risk and if you don’t take enough volatility risk you are guaranteeing that you will lose money. Don’t be short sighted – the current market volatility is nothing new – it has happened before and will happen again. Don’t panic and don’t lose sight of your plan. Sit it out and you will reap the rewards…or you can panic and buy yourself a guaranteed capital loss!

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