Has risk sensitivity altered as a result of the market crisis?
The Covid-19 pandemic has caused an economic shockwave in South Africa, leaving many investors scrambling to manage risk. During times of uncertainty, our perception of risk can change; we tend to think emotionally, rather than logically. This poses the question “should your long-term investment management strategy change in response to short-term environmental changes?”
What is investment risk?
The actions that you may take during times of market volatility such as selling some of your investments, or trusting your gut and doing nothing, can signify your risk tolerance. Essentially, your risk tolerance can be seen as the amount of risk you’re willing to accept to reach your investment goals.
An investor may have a relatively static risk tolerance, but during volatile times, they may change their portfolio management approach. Why? Their perception of risk changes. Risk perception can be defined as our short-lived, emotional sense of how much danger we may be facing.
Response to fear
Deciding on a course of action regarding your investments as a response to a fear factor can have detrimental consequences on your portfolio. Studies have shown that risk tolerance was typically stable before the global financial crisis between 2007 and 2008. After the crisis, risk awareness increased dramatically.
The Covid-19 pandemic has reiterated investors’ risk perception. Global research has shown that many investors moved substantial quantities of their portfolios to lower-risk investments during early 2020 before and during the start of lockdown in March.
How should perceived risk be managed?
So, how can you make sure that risk misunderstanding doesn’t lead to actions that could negatively affect you from accomplishing your investment goals?
- Make active, informed decisions
Take some time to study your investments so that you can make informed decisions based on options available to you when you may experience market volatility. Should you be unsure where to start, it’s a good idea to speak to an independent financial adviser. They can provide you with professional insight that should lead you in the correct direction.
- Assess the probability of loss accurately
The idea that you may lose money can be one of the primary drivers of perceived risk. Risk perception may cause you to misjudge the probability or degree of investment losses during market uncertainty. Furthermore, contemplating short-term risk and return measures can lead you awry.
- Risk and volatility may be necessary
It can be deduced that taking a certain amount of risk may be beneficial, but it is likely to introduce investment volatility. Still, it’s recommended that you focus on a long-term investment approach, so you can have a better chance of achieving real returns.
Utilise logical thinking
Even during times of market volatility, it’s unlikely that your risk tolerance will change. Risk perception, however, is typically affected and therefore should be managed effectively.
If you feel overwhelmed and feel as though you may make a panicked decision, take some time and evaluate your personal situation and investment goals. If you feel nothing significant has changed, it may be best not to take any action.