With as much as 50% of possible market returns uncollected due to bad decisions, David Quinn of Investwise wonders why individuals are so risk-averse

Most Irish people would like to imagine that they are risk-takers, to some degree. But they may well be thinking of going on a roller-coaster or jumping out of a plane as a risk. Ask specifically about taking an investment risks and people are still wary.

Risk is an important component in assessment of the prospects of an investment. Most investors while making an investment consider less risk as favourable.  However, the thumb rule is the higher the risk, the better the return.

Brokers now must consider an investor’s appetite for risk – their attitude to see how they feel about losses, their capacity to take a risk (how much they can afford to lose) and their appetite (how much they are willing to invest and lose).

While they take their clients’ viewpoint into account, many brokers themselves are risk averse when making recommendations to their clients. This is mainly due to misguided risk assessment processes, maybe some of their own biases as well as the existence of regulations, particularly the second EU Markets in Financial Instruments Directive (MIFID2).

In Association with

An investor may have the required positive attitude and healthy appetite, but they just can’t afford losses because of their own financial situation. And there again there are possible investors who have the funds but who are risk averse.

Past performance has a definite influence on what people perceive to be their appetite for risk and it is becoming obvious to me that many clients who have been managing their own investments take far too much risk. This can be through over-concentration (buying a single property or company shares with all their money) or through investment in just one single asset class (Bitcoin or gold).

It is important, therefore, to seek advice from a reliable broker. Without such advice many investors use low and medium-risk portfolios and only a tiny percentage use the highest risk funds. Interestingly, the highest risk equity funds give the best long-term returns in almost all cases.

Pension risk

US research institute Dalbar estimates that private investors leave 50% of the available stock market returns on the table through bad decisions, behavioural biases and market timing.

This appears to also be true for Irish investors who may not be taking enough risk with their portfolios, particularly when it applies to pensions.

Pension fund investment risk comes from three main sources: risk that the fund will fall in value, risk that the pension fund's returns will not keep pace with inflation (real returns are negative), and risk that the pension fund does not perform well enough to keep pace with the growth in the cost of providing pension benefits.

Members bear the investment risk in defined contribution schemes, personal pensions and PRSAs. Generally, employers bear the risk in funded defined benefit schemes, although if the employer cannot fund the scheme, the investment risk ultimately falls back on the member. It is, therefore, important that you know what risks you are taking within your pension fund and keep these under review.

Good investment performance reduces the cost and enhances the security of benefit promises in funded defined benefit schemes and increases the amount of benefits in defined contribution schemes, personal pensions and PRSAs. Poor investment performance has the opposite impact. It is therefore important that you know how the investments in your pension fund are performing over the long term.

Best Behaviour• 

Financial markets are largely driven by psychology. Investors make common psychological mistakes, and so the theories in the area of behavioural economics are regularly dissected and examined. And yet, people continue to repeat the same investment mistakes over and over. What is the message that we can take from this?

When I am looking at an investment decision, whether it’s my pension or elsewhere, I always ask myself would a completely random stranger living in Tokyo invest in the same thing. Would they buy a one-bed apartment? Would they leave all their savings in any particular financial institution? Would they invest in the company I work for?

Asking these questions is a great way to check where your biases lie and will also allow for a more calculated, less emotive, decision.

• David Quinn is managing director of financial and pension advisory firm Investwise, which offers a fee-only non-commission business model