This explains the wry industry assessment that investors are not so much risk averse as to loss averse. The notion that risk can be measured or benchmarked is also quite a sophisticated concept. If this is so and the investment that carries risk outperforms its benchmark, this ought to be viewed as a satisfactory outcome. This is not always the case. For example, if the benchmark shows a 10% return and the investment scores only a 5% return, the investor will not be congratulating his advisor on a wonderful performance.

A disappointed investor may then switch investments and advisors, punishing an advisor who has in fact done a professional job. The danger then is the investor may invest his money into something exotic with potentially disastrous consequences.

The text book definition of investment risk is the probability of earning a return that is less than the expected return. The greater this probability of a low return the higher the risk. Obviously no one puts money into an investment because a loss is the probable outcome. This is the risk that is taken in order to participate in an investment that similtaneously holds out the prospect of good returns.

Already we can see that a balance is being struck between risk and return. This balancing act is performed by anyone who is involved with structuring portfolios. When developing a portfolio, the key issue is the investment goal. A client should know his minimum acceptable return that is to be earned over the term of the investment. Some sort of benchmark should be in place to enable the investor and planner to gauge the acceptability of the investment performance.

The minimum acceptable return is the lowest return an investor must earn to meet the investment objective at the end of the investment horizon. A benchmark is an index used for comparative purposes and is usually representative of the category of securities into which the investor has decided to put his money.

The concept is best illustrated in a practical example. Imagine you have R100 000 to invest in a portfolio of unit trust funds. Your objective is long term capital appreciation and you have your advisor determine that you have a moderate risk profile. Your minimum acceptable return is the long term return of the JSE all share index, or some other representative index, that fits your investment style and philosophy.

There should be clarity on the appropriate benchmark. This avoids squabbles later, as it is possible for an investment to perform poorly against one yardstick but satisfactorily against another.

If an investor has a conservative risk profile he will not want to take any risk in achieving his minimum acceptable return. The objective may be to achieve returns in line with the JSE all share index. To achieve zero risk, a planner might construct the portfolio to exactly replicate the structure of the JSE all share index.

If your portfolio looks exactly like your benchmark, the risk of under performing the benchmark is zero. But remember you can take zero risk and still lose out. If the benchmark performs poorly, you perform poorly.

A risk taking investor takes measured risks in order to outperform a benchmark and thereby achieve higher returns. For this type of investor a portfolio would be constructed that would take into account economic trends and cyclical factors. It would be overweight in some market areas and underweight in others.

Time frames also influence risk. Stock market returns are volatile over the short term. In the case of short term losses there is no need for long term investors to panic. They should be aware that the stock market, on a long term, after tax basis, is the best place to be invested. Risk can be contained by achieving a balance of equities bonds and cash. But risk containment through appropriate balance is a subject all on its own.

Published in the January issue of SA Smart investor magazine. Written by Bennie Van Wyk, research analyst Momentum Advisory Service.