Some of us can be risk averse. And for good reason.
Perhaps you do not want to lose your hard-earned money, especially if that money might be needed for your child’s education or your retirement.
However, when it comes to your spare cash, veteran investor Howard Marks makes a good point.
For the uninitiated, Marks is the co-chairman of Oaktree Capital Management, a hedge fund specialising in alternative investments with assets under management of US$189 billion.
His latest memo highlighted a key point many do not talk about: the “risk of not taking a risk”.
In essence, you can play it safe by avoiding risks and parking your money in the bank.
However, by doing so, you will get little to no returns.
Your money will be eroded by inflation too.
The three types of risks
Marks goes further, highlighting another two risks.
The second approach is to take a moderate level of risk and accept a modest return for it.
Thirdly, he describes a scenario where an investor aims for a “substantial gain” but may suffer from permanent capital loss.
The problem with people who play it too safe and refuse to invest their money is that it will surely get eroded by inflation over time.
Hence, the risk of not taking risks.
The irony of avoiding risking your money is, itself, a risk.
The better way, he muses, is to choose between a healthy mix of the second and third types of risks to allow your money to at least keep pace with inflation.
Putting your capital to work
Now that you understand the need to put your capital to work, the next question is how you can control your risk to ensure you receive an adequate return.
Prudent investing, in my eyes, is about assessing and mitigating risks rather than avoiding them altogether.
One useful method is to look for companies that have a strong reputation, high market share and a long track record.
Blue-chip stocks come to mind as they are so-named because of their large size and ability to remain resilient through good times and bad.
Companies such as DBS Group (SGX: D05) and Singapore Exchange Limited (SGX: S68) have strong market positions and have paid dividends for many years.
Share price fluctuations are to be expected but the key thing is to focus on each company’s business performance.
Simply said, if the business does well, the stock will follow.
Stocks that pay dividends are another category to consider.
Dividends provide you with a flow of passive income and businesses that can maintain or even increase their dividends are worthy of long-term investment.
REITs such as Mapletree Logistics Trust (SGX: M44U) pay out quarterly dividends while dividend-paying stocks such as Haw Par Corporation (SGX: H02) or Boustead Singapore (SGX: F9D) also dish out reliable dividends.
Limiting the third risk
Howard Marks warns against chasing “substantial” profits thereby leaving yourself open to losing a big chunk of your original capital.
With the stock market being generally efficient, it is tough to eke out a large gain without taking on a correspondingly high amount of risk.
If you decide to invest in high-growth stocks, you should allocate a small proportion of your capital to high-growth, riskier stocks to ensure that you do not lose sleep should these investments turn sour.
By doing so, you can control the amount of risk you take without breaking your bank.
Get Smart: Taking calculated risks
What have we learnt so far?
We have established that not taking any risks is itself a risk as your money will lose its purchasing power to inflation.
The solution is to take calculated risks by investing your money in solid names that can generate a decent return over time.
It also helps if these stocks pay out dividends that provide you with a stream of passive income.
Should you choose to chase for higher returns, remember to limit your exposure accordingly so that you can sleep soundly at night.
By diligently putting your capital to work, you can see your investment portfolio grow steadily and achieve your dream retirement.
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Disclosure: Royston Yang owns shares of DBS Group, Boustead Singapore and Singapore Exchange Limited.
