Emphasis on returns misses the point

How often does the conversation with client's focus on what return they will get if they invest in X,Y or Z?

This conversation is often a specious one as it so often fails to recognise the far more crucial financial issues that most of our clients face:

-       How long will they live?

-       What happens if they become disabled prior to retirement?

-       How much will they save prior to retirement?

-       When will they retire?

-       How much capital will they have at retirement?

-       How much will they spend in retirement?

-       Do they have a will? What does it say?

During the recent credit crisis, there have been conversations with clients as a about the lack of returns they are enjoying. Many times they have formed the view that their position would change dramatically if they could only get a higher return. However a deeper analysis of their financial position shows that their situation is being influenced by much bigger issues, such as spending more than they had indicated when they built that new retirement dream house, thus diminishing their capital base considerably, or having given or loaned funds to family that was never anticipated, or the impact of the decision they made to invest some of their capital they hadn't told us about into a now failed finance company.

Returns are so often seen as absolute, reliable, attainable and to some degree straight forward. How often did we hear the conversation "If I invest my funds into this finance company I will get 8.5% as opposed to 7% from the bank."? It is as if the only part of the consideration prior to committing the capital to the investment is to get as bigger number as possible as the potential return. Nothing else really mattered.

Risk, which is inherent in every investment decision, even deposits in banks, can't be easily quantified by most private investors, but returns sometimes can. So the reliance on the "known" then becomes the focus of investor's attention.

There has been much comment from the likes of the Retirement Commissioner and the Capital Markets Task Force that better quality information will prevent private investors losing their money through selecting poor investments. With the greatest of respect to those who promote the "educational" approach, can someone tell me how?

Don't get me wrong, I understand the natural assumption proponents of the educational approach are making, i.e. better information will increase peoples understanding of the risks they are considering taking before they make that all important investment decision. But there are three key flaws in the educational pathway to investment enlightenment.

1. The assumption that all risks can be identified and described (what about the "unknown unknowns"?)
2. When risk is described, it is capable of being understood
3. All investors are able to be educated to a point where they can make fully informed investment decisions for themselves (i.e. become able to run their own investment portfolio)

If this objective were valid, why can't we all be capable of treating our own illnesses, repairing our own cars, building our own houses or even baking a cake?

The reality is we can't know all things. So when making investment decisions, how are we best to bridge that gap between the desire to make better investment and financial choices and the outcome from those decisions?

Encouraging the development of a fully professional financial advisory profession is a good start. Identification of those who are currently doing a good job for their clients would also be helpful. Ensuring key players in the financial advisory profession are promoting the benefits of getting advice and the questions consumers should ask when selecting an adviser. Enforcing the requirements of disclosure across all market participants and applying the law as it currently stands is also necessary.

If those in positions of influence want to really impact the lives of their fellow citizens, they should encourage investors to think of broader issues than just returns and pull back from the notion that every investor is capable of being their own adviser.

It would be my wish that the lessons of the last decade are not squandered in an attempt to control the uncontrollable. Risk is inherent in investing. Ultimately it cannot be removed, at best it is only able to be slightly moderated, and even then this moderation will not prevent people losing money.

Craig Myles is a director of financial planning firm Myles Wealth Management.

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