Risk and return

There are some articles in the newspaper recently commenting that investors are taking high risks and are not getting an adequate return for the risk. What does this mean?

REPLY:

Interest rate globally (and especially in Singapore) is at a low level. To earn a higher return, many investors are buying stocks and properties with low yields, and this cause the prices to go up.

When interest rate increases globally, there is the risk that the investors will move out of the stocks and properties and re-invest in bonds or fixed income. This will cause the stock market to correct severely.

For example, if long term interest rate in Singapore, currently at 3% p.a., were to increase to 5% p.a., there is the potential for the stockmarket to drop by 40%. This risk has not been factored in.

During a recession, the yield expected on risky assets will increase sharply. They will cause a sharper drop in the prices of these assets. This factor has not been taken into account now (as investors are quite complacent about it).