Page 24 - Waterfall Issue 4 2021

Waterfall News

TIME hoRIzoNS

Become a better investor by understanding the impact of time on risk.

By Adriaan Pask, CIO at PSG Wealth
M ost investors focus on the you will not only recover but

risk-return properties of
generate superior returns?
their securities or portfolios,
but factoring in a third Is cash really the lowest risk
dimension – time – can help you investment? While it is highly unlikely
make better investment decisions. that you will lose capital over a
12-month period, we know that, of
Traditional wisdom dictates that all asset classes, cash has the highest
securities and portfolios should probability of not generating inflation-
be selected or constructed after beating returns over the long term.
careful consideration of the risk-
return properties of each security It is important to note that if you
and the portfolio as a whole. This can reduce risk by extending a time
conventional method adopts a horizon, you can increase risk by
two-dimensional approach to reducing the time horizon. This is again
assessing assets: the consideration a critical consideration when investing.
of relative risk and relative return.
In academic circles, this is often traditional efficiency frontier? I would The riskiness of an asset class is not the
referred to as the efficiency frontier. certainly say so. By adding a third same over all time periods; it changes
dimension, investment horizon, to as the investment horizon is increased
What I have always found interesting the two-dimensional approach, we or decreased. This also means that if
about this approach is, firstly, there is can assess risk more accurately and you apply the wrong horizon to an
no consideration of time. Secondly, use asset classes more effectively. By investment, you could increase the risk.
risk is always defined as volatility. incorporating this third dimension into ultimately, the investor has the power
By virtue of these two seemingly our assessment or financial plan, we to alter the riskiness of an investment
inconspicuous assumptions, I believe can make better investment decisions. by extending or reducing the time
that investors can be led astray. horizon of their investment. Successful
So how do we use these new outcomes depend on having a
Let’s say, for example, you have investment superpowers to thorough understanding of the time
20 years left before retirement. In become a better investor? horizon you are investing for and
this scenario, your risk is perhaps how this should influence
not short-term volatility but rather Start with the investment your decisions. A
the risk of not saving enough for horizon, consider how much qualified financial
retirement or outliving your capital time you really have, think adviser can help
during retirement. At this stage of an about what you deem you factor this
investor’s life, these are clearly far more your risks to be over into your
serious risks than short-term volatility. that period, then stick overall plan
to your plan. Is losing effectively.
Another interesting observation is 30% of your capital
that the longer you invest, the closer over a 12-month
an asset class tends to move toward period really a risk
its long-term average return. Over the if you know that
short term, returns can vary greatly, over longer periods,
but the more time passes, the narrower
the range of outcomes becomes.

Is the asset class then potentially less
risky than what is assumed in the

22 Waterfall Issue 4 2021