In our second article with Rajen Devadason, we gain a new take on the risk-reward relationship, better understand why he believes we should start small when saving, and delve into the practicalities of diversifying your portfolio.
Rajen Devadason is a Licensed Financial Planner with Manulife Asset Management Services Berhad. The CEO of RD WealthCreation, he is a graduate of King’s College, University of London with an Honours degree in Physics and Computing. The FLY: Malaysia Journalism team caught up with him in Seremban in January to see what he had to say.
The True Risk-Reward Relationship?
In the investment lexicon, risk means volatility: the up-and-down movement of the price of a particular asset class between one point in time and another. To most who have heard the term before, however, it is often used as part of a technical term: the risk-reward relationship, which states that the more investment risk you take, the greater the reward that you will reap. Rajen, however, disagrees – and we asked him why.
“What [the risk-reward relationship] does mean is that the more investment risk you take, the more reward you hope to get. I can prove to you that the risk-reward relationship does not mean that the more risk you take, the more reward you will get,” Rajen explains. “Let’s play around with some numbers.”
“If your probability of failure in any investment venture is 10%, then your probability of success is 90%. If your probability of failure is 25%, your probability of success is 75%. Now I’m going to prove to you that it’s not a case of maximum risk, maximum reward! If you really want to examine maximum risk, let’s consider what happens when you have a 100% probability of failure. What then is your probability of success? Obviously 0%. Then if your target return for taking maximum risk is a 1000% reward but your probability of success is 0%, then your expected return is 1000 times 0, which is: 0!”
It is for precisely this reason that Rajen advises against wasting money on speculation and gambling. With the probability of failure outweighing that of success, he is bearish about the chances of retaining your capital, much less walking away with a return on your investments. In his opinion, cryptocurrencies are, at best, a speculation for those who know what they are doing, and wealth-destroying gambles for those who merely have hopped onto the bandwagon. Rajen’s view on gambling is clear: “You are creating a risk where there was no risk to begin with. Not smart!”
On Exchange-Traded Funds and Unit Trusts
As a financial planner, where does Rajen stand on the age-old debate between ETFs and unit trusts? Rajen concedes he may be biased. “I place my clients’ money within unit trust portfolios. Therefore, to whoever’s reading, please go and do your own research. There are pros and cons to both sides.”
Rajen does, however, point out that anyone expecting to have the versatility and manageability of a unit trust portfolio within an ETF setup is committing the folly of thinking you may have your cake and eat it, too. In order to have a professional financial planner or unit trust consultant managing your finances, there must be a reasonable amount of compensation, he says. He goes on to explain structuring such a remuneration model within the ETF world is difficult if not outright impossible, given the way ETFs are priced. More importantly, however, he holds that unit trusts have an edge over ETFs in one significant way. Rajen crafted this hypothetical situation to illustrate his point:
“Many years ago, the whole world figured there was a one-way trade with the Swiss franc. For a long time the Swiss franc got stronger and stronger. Now Switzerland is not that big a country…all the speculators in the world started buying the Swiss franc, [and] the upward revaluation of that currency started to hurt the Swiss economy enormously.”
“That’s one example. Here’s another: Imagine if you have an ETF-type situation like that – let’s say it’s an ETF specifically in palladium. Say something happens and everyone’s very excited and there’s only one palladium ETF. Suddenly, over a 6-month span because of exuberant news reports, a quarter of the world’s investment community dives into that solitary palladium ETF, which is priced based on supply and demand. The price will soar well into bubble territory. That’s what I’m concerned about, but as long as you have healthy buy and sell action, ETFs should be fine investments for most people. To their distinct advantage, unit trusts (or mutual funds in America) are revalued at the end of each day based on the market price of each component investment within those funds. This is a much better situation if you want to ensure the value of your investments is tied to genuine market basics.”
Ultimately, however, Rajen is less concerned with which particular vehicle investors opt to put their money in and says that one can easily utilise a combination of both. Of greater import is that investors learn how to diversify across their portfolio, and Rajen suggests looking at this from three different dimensions: across asset classes, geographic regions, and timelines.
Where the first is concerned, investors can opt to look at the various asset classes available in the Malaysian market – cash, fixed income, equities, investment real estate, and alternative investments like commodities. In diversifying across geographic regions, Rajen is adamant that investors avoid putting all their eggs into one basket. He advises Malaysian investors to spread their portfolio as much as possible beyond our shores and those of our immediate neighbours.
Finally, to diversify across timelines, Rajen highlights the importance of practising dollar-cost averaging, or for more experienced investors with much deeper pockets, value-cost averaging. “Let’s say you have a durian runtuh situation and suddenly RM 100,000 lands in your lap, and you decide that you want to put everything into risk-on assets: say equities or investment real estate. Say you do that in a single day, and two weeks later the market collapses.”
“Your problem was that you took concentrated risk across the timeline. But if you use dollar-cost averaging for instance, you actually then spread your purchases over many years, and so you ride the ups and downs [of the market].”
The 1%, and Earning the Right to Invest
Where most financial planners would advise saving anywhere between 10% to 25% of your monthly income, Rajen has a decidedly different take. For those who have never started saving before, he believes strongly that it is best to start small at 1% of their monthly income, and to gradually work their way up the ladder.
“If you find that you can handle [saving 1% of your income], then you will find that this powerful life principle kicks in: That money saved acts as a magnet for money earned! Try it. You have nothing to lose and there is no risk because should you run out of money you just take money from savings to pay whatever bill is stressing you out! After you have grown accustomed to 1%, and as more money flows into your life, then take it 2%, then to 3%, and so on over the years. If you are able to increase your savings and investment rate every quarter by one percentage point, then in about 12.5 years, you will get to 50%.”
Saving beyond 50% of your income is something that Rajen does not encourage, labelling that practice ‘hoarding’. More importantly, he stresses the fine line between saving for retirement and being able to spend on yourself in the present. “You don’t want to be over-saving and over-investing – you want to spend your money. You want to enjoy it. But you also want to be cognisant of the fact that you are likely to live a very long time. To readers who are in their early 20s, what will you do if you make it to the 22nd century? Specifically, if you live to be 105, and you only retire at the age of 75, which may be the norm in the 2070s, where is the [money for the next] 30 years going to come from?”
With this strategy in hand, Rajen focuses on helping his younger clients build a savings base for future investment opportunities, as they embark on what he terms ‘intense client education’. Throughout the decades-long process of wealth accumulation, he expects his clients to learn about the various asset classes and investment vehicles available at their disposal, and to ultimately be able to make informed decisions about their portfolio upon saving a respectable sum. In this regard, Rajen once again has a different view from most of his peers on investing at a young age.
“For young people, I actually refuse to let them invest. I want to see them save first. I’m in a real minority amongst financial planners because most people would say, ‘They’re young, they can handle up and down movements, they’ve got plenty of time.’ True, but when you’re young, you’re also very tender inside, and you usually don’t have the emotional internal fortitude to be able to handle, say, a 50% catastrophic market meltdown.”
“There’s a whole generation of new traders who have only seen a massive bull run,” he says, reflecting on the market recovery since the 2008 financial crisis. “Nothing goes up forever. Yes, for equities over 200 years of history, we have had a mega trend line going up – but along the way, it was a wild ride.”
“Can you imagine if you put a young person who has saved his angpau money because his parents forced him to do it for 10 years, and the first thing you do is go and put it in a high-risk investment, [and] a year later the market collapses? That’s going to leave an indelible scar – and yes, the markets will recover, but there will always be fear…Therefore, you want people to understand how to save first, to first earn the right to invest.”
 Exchange-traded funds are priced according to the auction system, i.e. supply and demand. As a result, it is difficult to factor in a service cost.
 Palladium is a precious metal that is extremely valuable. Unlike gold and silver, it derives its value from industrial usage, and by some accounts is even more valuable than platinum. For more information, read here.
This concludes our two-part series with Rajen Devadason. For part one, please click here.