Would you be shocked to know that in choosing one fund over another, you could potentially lose out on half a million euro? Yes, I did say HALF A MILLION.

Now, if you’re a regular reader of my blogs, you’ll know I am not a fan of picking an investment fund on the basis of its return, so you might be wondering if I’m feeling OK.

But this isn’t a hypothetical question, at least not for the client of a financial adviser friend of mine, and I’m perfectly well thank you. You see the fund made sense in the context of the man’s age, goals and circumstances, but still, he walked away.

The background

This client, a 33 year-old newly married man, wanted to start planning for his retirement. He was in a position to allocate €450 per month and he was comfortably covering his mortgage and other outgoings; he had his rainy day fund established.

This would be a retirement nest-egg, and he planned to work until he was 63. He had property (including his home) and cash, but no exposure to equities. For this reason, and because the man has a long time horizon before he retires, my friend suggested a fund made up of 99% equities, 1% cash.

Risk vs volatility

The life company offering the fund rates it at 5 on a scale of 1 to 7. It’s on the riskier end of the scale purely because of volatility rather than other risk factors.

There’s an important distinction.

The conventional wisdom in our line of business, and this is backed up by years of research, is that the equities markets will peak and trough plenty of times in those 30 years. The fund’s track record, as I expected, fluctuated (a lot). It went from -36.1% in 2008 to +26% in 2009, for example. That’s a huge swing, and in the right direction as it turns out, but it also dropped from 45.1% return in 1999 to -1.6% in 2000.

This is volatility, and it is of no concern to the investor because he has a long time horizon before he’s going to draw on that money. Over the period his money is still likely to grow.

Risk is different. In riskier investments, the probability of losses is increased by all sorts of factors that were absent from this fund; no gearing (borrowing by the fund proposers), no sectoral risk, no country risk, no counterparties… just a big bundle of international stocks and shares.

My friend showed his client the 20-year record of the fund with all its wild movements in both directions, and explained that, despite the volatility, the annualised growth of the fund in the period was 9.5%.

The client was also looking at a middle-of-the-road multi-asset fund, rated 4 on the same scale. It is made up of about 50% equities, the rest spread across short-term bonds, property and alternatives.

Here’s the half a million bit

The €450 held on deposit for 30 years adds up to €162,000 (making no allowance for inflation).

Here’s how it would fare in both funds:

Fund choice Average rate of return* Value in 30 years’ time
Multi-asset, middle of the road 5% €376,076
Equities heavy 9.5% €885,102

*These rates of return are not guaranteed, and there is a chance that both or either could be worth less at the end of the term.

By putting his money in the equities fund, he’d be earning OVER HALF A MILLION MORE than if he were to invest it in the multi-asset middle of the road. €509,026 to be exact.

Yet he chose the middle-of-the-road fund.

The perception of risk

Can you believe it? Why would you walk away from €500k more? Imagine what that would do for your retirement.

Here’s what had happened. The man had spoken to his dad, a former banker, who warned against anything high risk. He’d also spoken to his wife who, having heard the financial news all year, baulked at a fund made up of 99% equities.

Volatility was mistaken for risk. The man valued ‘advisers’ who did not understand what was being proposed.

The cost of that misconception was potentially half a million euro.

If you would like to reassess your options, get in touch to set up a free 30-minute call.