Why Risk Is The Safest Option - The Investor's Dilemma

When the world appears to be crashing down around us, it's in our nature as humans to batten down the hatches, barricade our defences, and reduce the risks we face in all areas of our lives. When it comes to decisions around how we invest our hard-earned savings, though, this could be entirely the wrong approach.


The last year of repeated lockdowns has been horrible in many ways. The threat of catching the dreaded virus has been present for us all, and as the spread of the virus has continued there are very many of us who have been affected personally, sometimes tragically losing someone close to us. Our first focus has been simply to survive.


Financial markets took a massive hit in March as the potential impact of coronavirus on the world economy started to become clear. Share prices in the UK's FT-SE 100 index fell by over 40% within a few days, causing huge alarm for many people who are relying on their investments to provide their future security.


It soon became clear that this kneejerk reaction had been overdone, and since then share and asset prices have continued to recover. As at the time of writing, most of our clients have experienced modest growth in their total wealth on a 12-month view, and if they were simply to measure the results from their holdings from the start of 2020 to the end, they wouldn't be overly concerned by what's happened to their money - in fact they would probably be moderately pleased.


But does that mean that people are ready to invest more money into shares and other assets? After a year of such drama in financial markets and elsewhere, the answer is probably not. It's highly tempting to simply avoid all of the potential stress, worry and palpitations that go with investing in such a way in favour of falling back on the safe, reliable and predictable bank or building society account. Hey, returns might not be very good, but at least I don't stand to lose everything.

Sunshine and storms; or constant drizzle?

The epidemiological storms might be coming to an end with the rapid dissemination of the new vaccines, but there remain financial storms to weather. Those storms have been ever-present throughout history, and seasoned investors have long-ago come to realise that an occasional financial drenching is the price that must be paid to have an opportunity to enjoy glorious sunsets in later years.


Relying on bank deposits alone for your savings is the equivalent of accepting a mild but constant shower of rain that will never stop. It's bearable, it's not too damaging, and it's much more attractive than the thunder and lightning that seem to go with other investments. But that constant, slow, persistent rain fall, in the form of inflation, will eventually wash the foundation out of your financial plans, or at best prevent them from building into anything grand.


And inflation is a real risk as we look to the future. Fortunately there are lessons that we can learn by looking at investing history, and these offer a useful guide as to what action to take today.


Perhaps one of the most interesting periods in living memory was the highly inflationary period of the 1970s. Throughout those years, stockmarkets soared and crashed as the global oil crisis shook the financial system, and the UK experienced annual inflation rates of over 20%, the highest since wartime. Investing in 'safe' bank deposits was no protection against the ravages of this dramatic price inflation, and over a 10-year period savers saw the purchasing power of their money fall to around a fifth of its previous level. In other words, whilst the 'nominal' value of their money had gone up in value, the 'real' value - what it would actually buy - fell like a stone.


Whilst stockmarkets were where the theatre was taking place, with all eyes focused on the gyrations of markets as shares rose and fell, it was those 'risky' assets that were the key to preserving the purchasing power of wealth. Share investors came through the period with the value of their funds intact in real terms, as share prices eventually responded to the economic growth that follows such events.


Share prices behave like this because they reflect the value of real-world businesses. And in times of inflation, those businesses respond to events by increasing their prices to remain in business and preserve their profits. This means that, in the long term, investors in those businesses should expect that the value of their investments will at least keep pace with inflation, unlike deposit accounts for which the returns on offer are directly linked to prevailing interest rates, which can lag far behind inflation for long periods.


This trade-off - between the apparent safety and calm of bank and building society savings, and the drama and volatility of investments in real assets - is at the heart of the investor's dilemma. Do you take the 'safe' option and risk losing purchasing power, guaranteeing that you will never generate sufficient returns to achieve your goals - or do you chose 'risky' assets as your investment of choice and harness the potential for the sort of returns that could mean the difference between a miserable future life and an exciting and contented one, whilst accepting the bumps and booms that go with that choice?

The purchasing power of cash deposits fell over the last 10 years

The good news is that a competent financial planner will be able to help you to create a portfolio that mixes risk, reward and safety in a way that takes the sting out of the bad times, but still enables you to profit from the good times. The events of the last 12 months have demonstrated how this can be achieved, and it's why we have so many happy clients for whom we have been able to provide a lifestyle in retirement that they never thought possible.


If you want to know more about our investment approach there's a lot of detail on our website, or call us for a chat and we'll be happy to explain. It's probably the least risky conversation you'll ever have!


Andy Jervis CFP

Chairman

January 2021



If you enjoyed this article you may also like these:


https://www.chestertonhouse.co.uk/post/financialfreedomframework


https://www.chestertonhouse.co.uk/post/_vbfp


https://www.chestertonhouse.co.uk/post/business-after-lockdown