The secret of happiness or rather the reason for unhappiness is the gap between our objective reality and our imagined expectations. If you imagine yourself flying 1st class, you are not likely to be very happy while sitting in coach. Like the advice, “don’t read beauty magazines as this will only make you feel ugly”. Accepting that there is always going to be someone richer, smarter, and / or more beautiful than yourself is the secret to inner peace and happiness. I am not saying don’t dream, but you may sometimes have to lower your expectations to meet your reality.
This is a great lesson for life and particularly for investing. There is often a mismatch between expected returns and the risk budget of the investor. Following a traditional approach to risk investors should expect a higher return for taking on more risk measured as volatility of return.
Although investors understand the theoretical risk / return chart they want the real (inflation plus) returns associated with equity investing, but with a smooth return profile of investing in cash. In other words, they want the returns, but not the volatility. I am afraid it doesn’t work that way.
Investing in equities will generate long-term real (inflation beating) returns, but not year on year. The range of returns when investing in pure equities over any given year could be anything from minus -50% to +50%. Investors need to be sure they can emotionally handle the volatility inherent to equity investing and then commit to an appropriate investment horizon depending on the risk / return budget of the investment. i.e. The appropriate investment horizon when investing in a share portfolio is 5 – 7 yrs.
Make sure you understand the risk / return budget of your investment and that it is in line with your return expectations and your risk tolerance level. Any conflict between the objective reality and your imagined expectations will end in much unhappiness.
Mcomm, CFP®, HdipTax
T. 021-851 3746