The first thing one is usually told about investing is that the higher the risk of the investment, the higher the potential return.
This holds true for most scenarios, but the current situation today seems to indicate something to the contrary: local risk assets seem to have stumbled dramatically and the equity market has provided lower returns in the short term. This has seen investors shy away from assets that are perceived as risky and flee to safe haven assets, which might not be in the long-term interests of these investors, especially younger investors.
The relationship between risk and return can evoke different reactions, depending on where an individual places more value, bearing in mind that there are basically no investments that are devoid of risk.
Why is it important to understand risk?
Understanding a person or group of people’s relationships to risk gives important insight into how one chooses to make decisions. This is even more true when looking at investments. Numerous studies over the years have identified a range of factors that affect one’s relationship towards risk – including gender, marital status, ethnic group, education and liquidity needs to name a few. However, one factor seems to stand out: age.
According to the StatsSA mid-year estimates, youth between the ages of 18 to 34 make up almost a third of the South African population. Furthermore, over 40 percent of the South African labour force is made up of South Africans in this age group. This makes them a very important demographic to understand. They have different spending and investing habits; are more acquainted with technology and social media; and, crucially, their unemployment has become a national crisis.
Age and risk – not as simple as it seems
Years of research has found that there exists an inverse relationship between risk tolerance and age. An individual’s risk tolerance speaks to their capacity as well as their appetite and willingness to take on risk. The traditional investment theory suggests that younger investors should take on much riskier assets to lock in the higher returns early. However, due to the subjective nature of risk tolerance, there is much more to this dynamic.
Looking at the effects or returns of investing for longer periods of time, many have found that the willingness to invest in a riskier manner when younger would lead to substantially higher returns in the long run.
When one starts investing early, they take full advantage of compound interest. For example, if I today were to put aside R1000 in an investment at an interest rate of 8% compounded annually for the next 35 years, when I reach the retirement age of 60, I would have R14 785 for my retirement. But if on the other hand I waited and only started to invest the same R1000 investments when I turned 35 (I can only assume I would be more financially stable by then), I would have only R6 848 at 60 years old. This is less than half of the amount saved above over only a 10-year difference. This effect of time and compound interest combined with the use of growth assets, such as equities, in an expanding market are a powerful combination. In that environment it would make sense to be more aggressive in the way one invests.
Just because something makes sense does not mean it makes sense for you. If you do not have the temperament to stay invested through tough, bad periods which may last a long time, then you will find yourself taking money out of your investment at the wrong time. This will result in you being worse off in the long run, even if you are young.
However, investing at an early age does give you the benefit of being able to stay invested during market downturns- because with time on your side, you are able to take advantage of the change in the tide.
The challenges facing SA millennials
However, for the vast majority of South African millennials, this is not a realistic option.
Although StatsSA states that the average salary in South Africa is around R21 000 per month, this is the case for the entire workforce. Research done by Giraffe focussed on South Africans between the ages of 18 and 35, stated that the average salary for the group is R6400 – much lower than the StatsSA figures imply.
Fin24 even reported that the South African average salary for an internship is R3950 per month. To make matters worse, a lot of these young people must pay tax, accommodation, transport, groceries and more, all this while assisting their families. Young South Africans have so little disposable income and are therefore very strained as consumers and investors. For many young South Africans, even if they are employed, stretching their monthly salary far enough to cover even the most basic expenses is a challenge.
In this bleak picture, young people are tasked with being the demographic to afford risk.
The Deloitte Millennials report 2019 stated that millennials and generation Z’s are uneasy and pessimistic about their careers, lives and the world around them. This is most likely due to the pressures they find themselves under on a daily basis. So how does the investment industry identify with these young people? Perhaps it is time to understand their situation and to design investment strategies that will accommodate their unique situation. It’s time to think differently.
A new approach
Young people may be different and require different thinking, but even we are not immune to the laws of poor planning. In the words of Benjamin Franklin supposedly, “If you fail to prepare, you are preparing to fail”.
While the ultimate financial goal should be to achieve income in retirement (the type that won’t lose value in time to inflation, and enough money saved up for unforeseen incidences and sudden loss of income), financial institutions need to acknowledge the challenges facing young people in the shorter term.
It’s also important to understand that, in the eyes of a more short-term focussed investor, the equity market may not always look appealing in the short term and timing is important. While an investor may focus on the short-term return, the South African equity market (FTSE/JSE All share Index) has not had a negative 5 year rolling period in over 25 years. Clearly communicating this to younger investors is crucial.
A holistic solution
Being a young person in South Africa comes with some challenges, and some opportunities. Social media and technology alongside innovative minds have made way for different forms of generating revenue and investing. There are bloggers, youtubers, and musicians being discovered through different avenues. Young people are no longer as traditional in terms of their work preferences. Gone are the days of staying in a job for 30 years and then getting a gold watch- it’s now also about flexibility. The “gig” economy is something that millennials have also embraced. 58% of SA’s young people have been found to want to be entrepreneurs, which is its own form of investing. These different forms of investing which may be more accessible and advantageous pose some doubts on some of the traditional investing methods and principles. They may not resonate with the majority of the youth today.
As young people we do face many challenges, and the ability to keep a cool head during turbulent times is a challenge for both the old and the young. Young people can afford to take on more risk. However, being young does not mean that you should automatically bear more risk. If you are reluctant to take more risk, even as a young person, you should not just do it because that is what is prescribed, but rather invest in a way that will ensure you make decisions which will benefit you, even in the long term.