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Business

Liam Dann: The big investment question testing our Covid response

21 Jun, 2020 12:00 AM5 minutes to read
What's your appetite for risk? Photo / 123RF

What's your appetite for risk? Photo / 123RF

Liam Dann
By
Liam Dann

Business Editor at Large

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What is your appetite for risk?

Are you a keen sky-diver or a dab hand on the roulette wheel? Are you an active share trader or content with a conservative KiwiSaver fund?

Whatever your threshold for danger, it's probably different to mine. It's probably unique to you.

In the investment world, assessing risk appetite is considered one of the most fundamental things to get right.

But it's also difficult and fraught with complex psychological issues, like emotional bias.

It really puts the "personal" in personal finance.

So it's not surprising that our policy response to the Covid-19 crisis is proving increasingly contentious.

READ MORE:
• Premium - Liam Dann: Why consumer confidence is 'better than expected'
• Premium - Liam Dann: Why strong lockdown gives NZ the economic edge
• Premium - Liam Dann: Is it time for another economic revolution?
• Premium - Liam Dann: We did it - now comes the shock of ordinary life

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The pandemic is forcing us to conduct a collective risk-appetite experiment on a national scale.

And as we move further from the immediate public health risk into the economic recovery, things are only going to get more complex, as the events of the past week have shown.

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Should we be progressively opening our borders ... to movie moguls ... to Australians ... to foreign students?

I still think we could, but if we decide to loosen restrictions to benefit the economy then we need to accept we are taking more risk.

There's a numbers game around border control.

The more people we let through, the higher the chance that we'll be let down by careless travellers, or by a human error in processing them, or a combination of both.

Despite my own disappointment about the recent high-profile quarantine bungles, no leader can realistically guarantee operational perfection.

In financial investment, nothing guarantees financial success.

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But the professionals know that if you have a strategy that fits your personal circumstances and your temperament (or your clients') it provides some insurance against disappointment.

I've heard highly successful investors talk about being sure that your investment strategy passes the "sleep at night test".

In other words, if you are taking so much risk that you can't sleep then something is out of whack.

Life's too short to spend it worrying all the time.

When New Zealand's finance companies collapsed in 2009 and 2010, the greatest shame was that many investors were misled about the level of risk they were taking.

Numerous finance companies built marketing strategies that made them appear cautious and sensible while they were actually taking extreme risks investing in the speculative end of the property market.

In hindsight, the rates of return on offer, relative to bank rates, should have been a reasonable clue.

But hindsight is a fine thing and in some cases the level of risk was criminally concealed.

That's an extreme example but it highlights that one of the most important issues in any risky endeavour is understanding the odds.

This sounds easy but is complicated by the problem that most humans think they are good at it understanding odds. In fact, most of us are not.

Animals assess odds intuitively, whereas humans let their theories and biases cloud the logic. There's research to prove it.

In his bestseller The Drunkard's Walk: How Randomness Rules Our Lives, Physicist Leonard Mlodinow writes of an experiment where a light is set up to randomly flash either red or green.

The subject was rewarded for predicting the next colour in the sequence.

Rats and humans were both tested.

The trick was that the green light was set to flash 75 per cent of the time.

The rats quickly worked this out and started picking green every time - ensuring a 75 per cent success rate and bountiful sugary treats.

Humans, embarrassingly, had a success rate of only 60 per cent.

The bigger-brained homo sapiens spent most of the experiment trying to see patterns in the sequencing of the lights that didn't exist.

In this pandemic, most of us have been prepared to concede a lack of specialist medical knowledge.

"I'm no epidemiologist but ..."

We're generally still very sure in our opinions about the merits and risks of specific policies.

Perhaps we shouldn't be.

Is it the Government's role, as the guardian of our physical and economic health, to land on a risk assessment that aligns with majority of the population, or one that aligns with the experts?

And which experts?

It's a balancing act.

We need to be highly skilled and experienced people to present choices and make clear the odds around those choices.

Then we need a Government to weigh those against public opinion.

Prime Minister Jacinda Ardern at a post-cabinet briefing. The director-general Dr Ashley Bloomfield, right, delivers the daily New Zealand COVID-19 update from Parliament. File Photo.
Prime Minister Jacinda Ardern at a post-cabinet briefing. The director-general Dr Ashley Bloomfield, right, delivers the daily New Zealand COVID-19 update from Parliament. File Photo.

Governments usually want to get re-elected, so there's motivation to do that.

But that adds a risk of pandering to uninformed, populist views that often lean towards short-term fixes.

So far, success in both controlling the virus and the political polls indicates the Government has struck a good balance.

New Zealanders have clearly been collectively more cautious about the health risks of Covid-19 than many other nations.

Other countries are now opening up to tourists, with daily death tolls still in the hundreds.

Neither health experts, economists nor the vast majority of New Zealanders are prepared to live with that.

But as time marches on and the world gets on with living with this virus, New Zealanders will increasingly face tough choices between risk and reward.

We shouldn't forget those choices are luxury that many nations no longer have.

But we shouldn't underestimate the challenges of making them.

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