Risk, Reward, And Return On Investment: Are You A Good Investor?

If you have a lot of investments, then finding out if you’re a good investor is something you should take a closer look at…

by Simon Popple of Brookville Capital

Being a bad investor is like being bad in bed!


Much like gambling. Everyone is happy to share their good results but you rarely hear about the bad ones. We tend to keep rather quiet about those!


What is a good investor?


There are many facets to being a smart investor. A “good return” being one.


But there’s more to it than that.


Several other things you need to think about. And that’s what I want to talk you about today.


Firstly, what risk have you taken to get that good return. If you’ve gambled your money on a horse, you’d expect a big payday – you’ve taken a lot of risk. You can see it jumping the fences and know there’s a lot that can go wrong.


What about your other investments?


When you invest in a company you don’t see the fences. You know about the horse, perhaps the course, but as a shareholder you’re blissfully unaware of any trials and tribulations until the results are announced.


You can’t see the fences.


You want lower risk. Makes perfect sense.


But how much risk are you taking?


You happily deposit the money with your broker – then wait and see.


Fortunately, there are tools at your disposal to measure your “risk / return”


The Sharpe ratio was developed by Nobel laureate William F. Sharpe. It’s used to help investors understand the return of an investment compared to its risk. The ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk.


In layman’s speak. If you deduct the “risk-free rate” (such as UK Gilts) from the return you get. You can isolate the surplus – which is essentially the profits associated with risk-taking activities. If you compare this to other investments with similar risk (from other product providers) – you’ll know whether you’re getting a good return relative to the risk you’re taking.


If you make a lot of investments, this is something you should take a closer look at.


It’s not rocket science.


Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return.


Simply asking your broker could be enough to make them a little bit more careful about how they are investing your money.


The second point I want to touch upon is purchasing power.


If you invest £10 which at the time can buy you three pints of larger and 12 months later you receive £12 but that can only buy two pints, you’ve lost purchasing power – despite making what on the face of it, looks like a pretty good return.


Although there’s no constant in economics. In any market all goods, assets, currencies, etc. continuously fluctuate in value relative to each other due to ever changing supply and demand dynamics.


Gold seems better than most, so could be considered as one way of securing one’s purchasing power.


By way of example. In the week from January 4 until January 9, 2016, the price of gold in British pounds surged 5.9 % from £23,096 pound per Kg to £24,469 per Kg. We can be reasonably confident that the price of goods and services in the UK remained broadly flat during this period. As a consequence, in this example gold could buy 5.9 % more goods and services at the end of the week, whilst sterling could buy exactly the same amount of goods and services all week long. So, in this particular example, what was more constant? It was sterling. But I would argue, that over the longer terms (particularly with Brexit around the corner) – it will be gold.


In this example – if you wanted to improve your purchasing power, you should have held gold.


One of the great myths with gold is that one ounce has always bought the equivalent of a man’s suit.


There have certainly been times where this is true, but it hasn’t always been the case.


Sometimes the gold price is low relative to what a suit costs, and other times it’s higher.


It’s all about timing.


Right now, an ounce of gold is about US$1,400 per ounce. Which is a pretty nice suit.


But where could the price of gold go?


Some research from “Gold Silver” estimates that there are roughly $40,000 of liquid financial investments available per person. And in stark contrast, there’s just $200 of investment grade gold per person.


The gold market is clearly tiny by comparison to financial assets.


Imagine if 10% of those assets were re-allocated to buy gold – $4,000 of new demand per person to buy gold. And remember it’s only about $200 right now.


You can’t print gold. So the price should go up….a lot


Although it’s unclear how many investors will turn to gold should we have a crisis, the potential is enormous.


So much potential, in fact, that gold won’t just maintain its purchasing power, but could push your standard of living a lot higher.


You’ll probably be able to buy a lot more than a new suit with your ounce of gold.


But what about the downside?


All I would say is that right now, I see more risks to not owning, rather than owning gold.


Don’t say I didn’t warn you.

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