Evaluating risk and assessing risk appetite

NewShadow

I've got around 10k in an AJ bell LISA and 9k in a vanguard ISA, both were in global funds (blackrock consensus and lifestrategy)

They've done fairly well this year due to the drop in value of the pound but this recent fluctuation, up 5% in a week, has tested my resolve and I've actually withdrawn from the market (sales pending) to re-evaluate my personal risk appetite.

I've seen a few posts which say something like 'you're risking a 70% loss in that fund' or there's a 80% chance of loss in the first year reducing to 20% in the 5th year - typically can't find any to quote right now...

Is there a table anywhere roughly hashing out the probabilities of loss and gain over a term in funds with different equity percentages based on historic trends?

Or is it more that equity is a 100% risk therefore an 80% equity fund risks 80% of it's capital in year one but recovery and gain is more likely by year 5/6/7?

I'm wondering how to calculate the relative risk of the blackrock and life strategy equity funds to help me consider my personal risk level.

For clarity on my goal - I'm currently saving a portion of my income and have earmarked it for a house deposit. Given my current job and immediate plans the actual purchase won't happen for, probably, the next 5/6 years - maybe as much as 10.

thegentleway

I'm a newb so not sure if this is helpful but I thought this tool was pretty good to get a grasp of returns.

Rule of thumb I saw was the max you should invest in equity is double the max you can stomach to watch yourself lose in short term. I.e. if you can stomach a 30% loss then you should have 60% max in equities.

System

There absolutely is a chart, it is posted often in the ukpersonalfinance sub-Reddit and I keep forgetting to bookmark it.

Here's one for the S&P 500 though and most investments follow a similar theme.



You can look at the graph of growth for the funds you've got and see for yourself. Pick a point just before a large dip and see how long it takes to recover. But beware past performance isn't a guarantee of future.

Linton

NewShadow wrote: »

......Or is it more that equity is a 100% risk therefore an 80% equity fund risks 80% of it's capital in year one but recovery and gain is more likely by year 5/6/7?

No

There are two different risks here. One is that the investment goes bust and you loose everything. That is why investing in just one share is a bad idea. However, if you invest in funds you are likely to be investing in 100's of individual companies. The chance of them all going bust is virtually zero, and if they did that would be the end of the world as we know it, and your investments would be the least of your problems.

The risk we are mainly talking about is temporary major falls in equity prices typically due to real economic problems hitting the major economies or to the fear that such problems may be on their way. Such falls are frequently in the 10-20% region and may on occasion rise to 40-50% if you invest broadly in solid companies in the mature economies. Of course if you invest highly in riskier areas - eg emerging markets, small companies, raw materials the losses could be greater.

The size of losses could also be higher if you ignore the advice to invest broadly and instead choose a few niche areas - individual sectors can be high risk at times, you need to hold a broad range.

The equity in an 80% fund will behave as described. The other 20% is usually held in safe bonds which are much less volatile, but provide a lower return. 20% cash would also provide a similar role. So an 80% fund would be expected to have fluctuations 80% of the size of a 100% fund.

The expectation is that after a fall in equity prices there will be a recovery in a relatively small number of years. If you didnt believe that, you would be foolish to invest at all.

The real risk to your wealth then isnt the drop in prices but rather your reaction to the drop in prices. If you are of a nervous disposition a 40% fall in prices could make you sell the lot and so miss out on the recovery. You should use less risky investments to protect your wealth from yourself. On the other hand if you are too risk averse your returns will be low, so in general it does not make sense to invest with a lower % equity than you are happy to hold. Its a balance.

NewShadow

Linton wrote: »

No

There are two different risks here. One is that the investment goes bust and you loose everything. That is why investing in just one share is a bad idea. However, if you invest in funds you are likely to be investing in 100's of individual companies. The chance of them all going bust is virtually zero, and if they did that would be the end of the world as we know it, and your investments would be the least of your problems.

The risk we are mainly talking about is temporary major falls in equity prices typically due to real economic problems hitting the major economies or to the fear that such problems may be on their way. Such falls are frequently in the 10-20% region and may on occasion rise to 40-50% if you invest broadly in solid companies in the mature economies. Of course if you invest highly in riskier areas - eg emerging markets, small companies, raw materials the losses could be greater.

Thank you for this - even if it does make my head hurt...

So the first factor is the equity split - an 80% equity fund in reasonably solid global investments could lose 50% in the event of a serious (global recession style) market shock, which would be 40% of the portfolio. In the same situation a 40% equity fund would be at the same risk but only lose 20% of the total because of the equity split... It would be expected to recover over time so it becomes about my appetite to ride out the paper loss and the risk is I can't access my money during a low point without realising an actual loss.

The second factor is then the companies invested in within the fund - with funds like fundsmith holding fewer companies than one of the life strategy funds - so it becomes a question of how much I trust the fund manager to balance risky new markets with established safe companies... smaller funds with fewer 'exciting' companies could also lose the 50% if some of the companies collapsed due to market pressures and would be less likely to make the recovery over time.

Assuming - which is a big assumption - I've got that right... I'm going to do some reading this weekend before considering where to put my money - can anyone recommend a better place than the HL fund pages to compare relative composition and performance of funds?

Linton

Your first factor analysis is correct.

The second factor analysis is less important in that most funds will hold at least say 50 shares, so the risk from a company going bust is not great. More of a problem would be that the niche funds tend to focus on particular geographies or types of company, so leading to higher volatility eg if a fund manager happened to like banking his fund would have suffered greatly in 2008/2009. Other high performing funds focus on technology which has been a good choice for many years. The dot com crash about 15 years ago was a disaster for them and their investors.

A good place to look at the composition of funds and other detailed information is www.trustnet.com. Also morningstar has a lot of data but I find its indexing makes it rather more difficult to locate individual funds there.