Part three - Risk
In the final part of this series, I’m looking right in the eyes of the elephant in the room: risk.
This small but powerful word is one of the biggest factors in why people don’t invest. Just seeing the phrase ‘capital at risk’, the constant companion of investment opportunities and financial products, is enough to put many of us off. But why? What is it about risk that feels so scary?
Humans are innately risk averse
It’s in our biological design to turn away from things that feel dangerous, it’s part of our innate survival instincts that have, so far, served us very well. They come in handy when faced with a predator, but less so when we can’t help but interpret the very idea of losing money as a mortal threat. This doesn’t mean that we can’t learn to work with our instincts, though, instead of them working against us. The best way to do that is through education; if we can learn to differentiate the real vs the theoretical risks of investing, and remind ourselves of those when we feel our instincts kicking in and telling us to run a mile, then we won’t be as affected by the natural biases of our own psychology.
What is it that makes investing feel risky?
Three very simple words: capital at risk. Risk is right there in the disclaimer of nearly all financial products and investment opportunities, so of course it feels risky… the very people trying to incentivise you to invest are also telling you that it’s dangerous. Therefore it’s an entirely natural response to think that, whatever the benefits might be, it isn’t worth it.
And if the disclaimer doesn’t put you off, the scary headlines (that for lots of us are our first introduction to investing) undoubtedly will. When trusted news sources come forward with headlines like ‘Is it time to sell before we hit bottom’? Or ‘what the market meltdown means for your money’ it serves as validation for our fears that bad things can happen to your money when you invest.
But what both headlines and disclaimers have in common is this: a lack of context that makes it seem as though all investments hold the same level of risk and that level is enormous and just not worth it. This is an issue, not only because it’s inaccurate, but because it's so very off putting to people who are already inclined to believe that investing ‘isn’t for them’ because it’s exclusive, as I mentioned in part II.
Not all risk is the same
The most important thing to remember about risk, in terms of investing, is that there are lots of different levels of it. Yes, there are some investments that have great levels of risk, but who says you have to go anywhere near those ones? While the idea that the bigger the risk, the bigger the return may be true in some cases, it doesn’t mean you can’t get a good return on investments that have lower risk levels.
Some risks aren’t what they seem
Perhaps the biggest worry that people have about investing is the idea that one day their money will suddenly completely disappear, but the chances of this are actually very unlikely. Here’s why:
- If you ‘spread your eggs’, as it were, across multiple investments rather than putting them all in one basket, i.e. putting money into a number of ETFs or multi asset funds that invest in lots of different companies rather than putting all of your money into buying shares in one company, then it’s almost impossible to lose all of your money. That’s because if one basket drops and the eggs crack, you have all your other baskets still going and increasing in value over time. This is why having a diverse portfolio is really important, because it helps to mitigate the risk of losing money.
- It’s normal for investments to fluctuate in value, so a short-term decrease in the value of your investment is fairly likely, but remember that losing value isn’t the same as losing money. You only lose money if you sell your investment when the value is down. Over time the stock market rises, that’s just a fact – look at the FTSE 100 or the S&P 500 or any other market, and you’ll see an upwards trend if you zoom out and look at it over a longer period of time. This is why investments are best held in the long-term, because time allows you to weather any ups and downs in value. So as long as you are thinking about investing for the long term, you need to be far less worried about short term gains and questions like ‘has my investment gone up or down today?’
- There’s the misconception that fund managers (the people who take care of investments) have the ability to run off in the night with all your money leaving you with nothing, but this really is just that: a misconception. There have been one or two anomalous situations in the past few decades where a bad fund manager has made a bad choice and it’s impacted the people who have invested with that manager. Unfortunately these are the stories that make the headlines which makes it seem like a real possibility – but it isn’t, not with highly regulated funds which is the kind of thing public investors (like you and me) would be investing in. Regulated funds have such stringent regulations to keep fund managers in check and protect consumer-invested funds, with numerous levels of daily checking of those assets. And, many funds (particularly ETFs) follow an index (like the FTSE 100) so there’s no ‘crystal ball’ decision making by a manager anyway, they just help the fund track what’s happening – so no one person can run off or gamble with your money.
There’s risk everywhere
It can sound a bit scary, but I prefer to think of it as liberating. The fact is, there’s risks with everything – let’s use the example of property. People often fall into the trap of saying that property is a ‘safe’ investment. That’s because it’s a physical thing, it’s bricks and mortar that you own – but that doesn’t mean it’s immune to risk. The property market may not appear as seemingly volatile as some stock markets, but it does fluctuate – and we have no more control over that than we do over the markets or the general economy. Just because you can physically hold on to your house, doesn’t mean you can stick its value in place. There is a risk you can lose money with property as there is with any other investment; you may buy a one bed flat knowing that they’re selling really well at that time, but by the time you want to sell it, maybe COVID has struck and everyone is in a garden flat and you’re stuck paying for a property that you can’t sell for a while. There are risks with everything – and when you accept that, suddenly it feels a bit less scary to invest in something else.
There are risks to not investing, too
And, speaking or risks, there’s risks to not making that first step to investing, too. In the moment it might feel safer to keep all of your savings in a current account, but with interest rates being so low and inflation rising every year, the money in your current account will actually be losing value the longer you keep it there, because it isn’t growing in line with the economy. In fact, you could lose around 2% every year on money in your current account because of inflation. This is because the cost of everything is increasing at approximately 2% every year, but your money isn’t keeping up with it if it’s in an account with an interest rate that’s lower than this. So by not investing, you are literally losing money.
Risk is a reality, but its outcomes aren’t an inevitability
Yes, investing has risk but, as I’ve hopefully helped you see here, not all risks are born equal. Losing money is not a guarantee just because financial institutions have to tell you it’s a possibility, and possibility isn’t the same as inevitability. As long as you do your research, spread your eggs and be prepared to sit tight (ideally at least 3-5 years), the ultimate risk of losing money can be mitigated.
In taking the time to acknowledge and understand risk, we can take some of the fear away from it which in turn can open up a whole world of possibility to make your money work harder for you (...and beat inflation!). But, as with most things in life, you have to take the first step to really see that it isn't as scary as you think it is.