Back in 2014, I wrote a blogpost called The Ice Sculpture and The Turkey that talked about the risks of investing (and the risks of not investing).
I was reminded of this when discussing investment risks recently with Andy Hart from The Maven Money podcast. You can watch our discussion on investing here:
You can boil down the risks of investing into 3 main types:
1. The Ice Sculpture (Inflation)
Do you think that cash is safe and the stockmarket is dangerous?
Wrong. Your cash is like an ice sculpture at a party. You can’t see it melting away…but it is. Inflation guarantees that your cash will lose its real value over the long term.
With 3% inflation and 0.5% interest rates, you are losing 2.5% a year. That means your cash loses HALF of its value every 29 years or so.
Safety is relative. And total safety is an expensive illusion.
2. The Turkey (Loss of capital)
Real risk is the permanent loss of capital…its where something goes down and it ain’t going back up again. Like The Titanic for example.
Many investments look safe and predictable but the risk is swept under under the carpet. For example, P2P lending, high yield bonds or emerging market debt combine an obvious but limited upside with a hidden risk of total wipe out.
Take those P2P lending platforms that offer you ~10% interest (at a time when safe savings earn ~1%). For years, I’ve been saying that P2P is mostly sub-prime lending. In other words, the sort of thing that led to the last financial crisis. Recently we’ve seen Lendy go pop, Funding Circle wobble and that’s before a recession that would really spike loan defaults.
Investors in P2P Lending are like turkeys on a farm. They get fed…until the game changes.
3. The Roller Coaster (volatility)
Share price volatility is just numbers going up and down on a screen and, most of the time, that doesn’t mean anything…its mostly noise rather than signal.
Many people think that property is safe just because they can’t see the price going up and down. But what if we put an electronic ticker-tape at the top of your house and each time an estate agent or property developer walked past, their guestimate of value was shown as a price? Result: price volatility but no extra real risk.
Owning shares means you own a slice of the real economy. You share in the abundance created by technological progress.
Investing in the stockmarket is simple. Just make sure that you are never a panicked / forced seller of shares in a bear market.
Stockmarket volatility is like a rollercoaster. If you stay strapped in, its just harmless fun. But if you get out halfway through the ride, you get screwed. I know because I’ve been that guy.
Bear markets are the friend of the long term investor. If your supermarket temporarily marked everything down by 50% you’d respond by stocking up. Why should stockmarket investing be any different?
Answer: it shouldn’t. If you are a net saver (and if you’re reading this website then you probably are) then you should be hoping for the stockmarket to fall so that you get more for your money every month.
Yes I can prove that. This table shows the benefits of drip-feeding money into a volatile market (that feels uncomfortable) compared to a smoothly rising market (that feels better).
The lower the index level at the time of investing, the more units each £ / $ buys and so the more shares in real businesses with real assets the investor ends up owning.
The investor’s portfolio ends up worth more in a flat, volatile market…even with a price level 28% lower at the end of year 5,. And the difference in the number of shares owned is striking. The investor in the flat, volatile market ends up with 42% more shares.
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