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Don't take a chance on your retirement investments

During Chinese New Year reunions, many of us gamble a little with family and friends to pass the time. Suppose when playing Sic Bo (買大細), five consecutive Bigs are rolled. What would your next bet be? Would you go with the Big trend or take a chance on Small?

Rationally, we know that the number of Bigs or Smalls previously rolled has nothing to do with the outcome of the next game. The outcome of every roll is unrelated and unpredictable. It is all about statistics and odds. However, when we place our bets, we make projections without scientific merit and believe we can make the right guess.

Don't be overconfident and ignore risks

Don't be overconfident and ignore risks

Sic Bo is strictly a game of chance, but we still try hard to make a good guess, just as we might in the investment market, which is full of information and investment advice. In a bull market, when asset values keep rising, do we make a profit because we are lucky or because we have a sharp eye for investment? Though it can be hard to tell for certain, in a bull market, average investors tend to attribute their success to their insight and strategy. When it happens over and over, this can turn into what many experts refer to as “overconfidence bias”, prompting people to believe they have the Midas touch for investing.
When it comes to managing your retirement investments, overconfidence can have a negative impact. For instance, after investing in certain asset classes and repeatedly making a profit, you may be tempted to invest all your assets in these asset classes, which leads to over-concentration of your investments and higher risk. If you believe you have a better investment eye than others, you may ignore warnings about increased risk in the blind pursuit of short-term returns, believing you can “win big” in the short term and ignore long-term planning. Renowned investor Warren Buffett once said, "You only find out who is swimming naked when the tide goes out." Likewise, only in a bear market do we realize how much of our investment gains were due to a bull market, and just as a ship rises and falls with the tide, we begin to understand that nothing rises all the time. The market is always part of a cycle, rising and falling.

“Compounding effect” – the eighth wonder of the world

“Compounding effect” – the eighth wonder of the world

So how can we overcome “overconfidence bias”? We need to understand that if we want to be a winner in the investment market in the long run, we have to avoid trying to time the market (i.e. capturing short-time market rises and falls). Instead, we have to leverage our time in the market, letting our investments generate returns through the long-term compounding effect. Your retirement investment, which grows over decades, can benefit significantly from the power of the compounding.

Let’s use an example to understand the power of compounding effect, once described by Albert Einstein as the “eighth wonder of the world”. Say a person saves $1,000 a month for his retirement investment, starting from the age of 20. Assuming his annualized return is 5%, he will have accumulated $410,000 by the time he is 40, after 20 years of continuous investment with the compounding effect. If he saves for 40 years, he will have accumulated $1.53 million by the time he turns 60. Though he has only doubled his investment period from 20 to 40 years, the additional amount accrued is nearly threefold! In comparison, many investors record losses when they try to speculate on short-term market gains.

Risk management and investment diversification

Risk management and investment diversification

A good retirement investment portfolio needs to balance risks and returns. One way to manage investment risks is through diversification. Research has shown that good diversification is one way of achieving better investment outcomes in the long run for a given level of risk. Taking the MPF as an example, you can diversify your capital across different asset classes (such as stocks or bonds) and regions (such as global markets), according to your investment objectives and risk tolerance level. You can also choose to adopt the Default Investment Strategy, which has three key features: (1) automatic reduction of investment risk as members approach retirement age; (2) fee caps set at 0.95%; and (3) global investment for risk diversification.

Diversify your investment appropriately. Be aware of the risks and don’t take a chance on your retirement investments! Start early to take maximum advantage of the compounding effect to create wealth for retirement without relying on “guesses”.
Kenny Mak – Chartered Financial Analyst
Click here to series of “Overcoming blind spots for a happy retirement”
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