May 19, 2019

Why is investing not risk-free?

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In writing this piece, I’m inclined to reflect on the saying that “there is no such thing as a free lunch”. Everything in life has both negative and positive aspects to it. It’s just that sometimes we don’t see the negatives or if we do, we choose to ignore them in favour of the more comfortable outcome that we desire.

Personal investing falls into this overall category as well. Over the many years of advising clients I have often been asked about what do I think about a particular investment? Is it a good investment? Should I invest now in it?

Sometimes the client conversations are more direct and I am told that another adviser is generating far higher returns for his investment clients than I am. And surprisingly I will agree with these assertions that I am not producing as high a return for that particular client. But like everything in life, it depends on the context. In the investment world it is always possible to generate high returns but not necessarily high returns within an investors personal risk tolerance! And this is the point about personal investment advice being personal.

The “no free lunch” equivalent in investing works at both ends of the scale. High investment returns do not come without taking high investment risk. Sometime the risk is that extreme it’s like placing a bet on a single number on a roulette table and hoping that the ball does not land on one of the other 35 numbers. An all or nothing scenario. If it falls on your number you’re in the money. If it doesn’t you’re wiped out. This type of approach was very evident in a cold analysis of the fallout of the Celtic Tiger.

At the other end of the scale is the apparent security of holding cash. But this too comes with its own risks. Leaving aside the potential of not keeping up with inflation and a fall in the purchasing power of your money, the financial creditability of the bank that you leave your money with needs to be investigated before depositing your funds and thereafter kept under constant review. Just ask the deposit holders who had more than €100,000 held with Newbridge Credit Union or even the Russian Oligarchs who lost millions that were held on deposit with Cypriot banks.

Good investment is about spreading risk to match an investor’s appetite to that risk. Take too much and the investment monies might get decimated, take too little and you will probably have a discontented client. The key to investing lies actually in the client, not the investment market or the investment product.

The key to good investing is figuring out what the appropriate level of risk is and means identifying:

1. The goals of an investor and the financial consequences of such goals,

2. The financial ability of the investor to rebound if the investments underperform or get destroyed,

3. The investor’s risk tolerance in the event that the investment turns sour.

This is not a “one size fits all” agenda. Proper investing means personal investing with due reference to the individual. Of course, this is the theory. Sometimes reality produces blindspots in investors’ perspectives such as an unrealistic investment return needed to sate an appetite for an unsustainable lifestyle. Investment advisers are not magicians – they cannot perform miracles just because a client wills for an unrealistic outcome. Any adviser who presents themselves otherwise is either a charlatan or a fool. Those that blindly followed Bernie Madoff in his exploitation of his “private investment clients” realised too late that they were the victims of an elaborate and elongated Ponzi scheme.

The bottom line with investing is that risk is everywhere but not necessarily obviously everywhere. In the same way that “Caveat Emptor” applies to buyers, a similar warning is necessary for investors.

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