As the markets tumble, it’s time to define: what is risk?

Date Published:11/08/2011

The “risk-free” investment has always been the holy grail of investors – whether they live in Stratford upon Avon, or Stratford, Connecticut, USA.

In the past, traditional wisdom has been that there isn’t an investment “as safe as houses” whilst until recently, within the investment profession, the closest to a “risk-free” option has been the return from short-term US Government Bonds known as Treasury Bills (T-Bills). This may no longer be the case.

Stratfordians will not have been able to avoid the recent headlines and pages of analysis concerning the implications of the US Government defaulting on its obligations and plunging global economies back into crisis.

Fortunately, at the eleventh hour, whilst nails were being bitten to the quick in money markets across the globe, President Obama managed to agree a compromise with all sides of Congress and Senate, meaning that disaster was averted….this time.

Yet whilst this drama was being played out in the US, problems in the Euro Zone have not abated.

Difficulties in Spain and Portugal, Ireland and Greece may look like they’ve gone away for the time being, but they will almost certainly return. However, the most immediate problem is now emerging in Italy, as that country now enters into crisis talks with the EU. This has been triggered after the yields of Italian 10-year bonds rose to a level regarded as unsustainable. The yield on Spanish 10-year bonds is equally unsustainable.

What does this mean for investors? Well, the answer is relatively simple: risky investments are still risky, and less risky investments are still less risky.

However, the real issue is in defining which investments fit into which category and which should be invested into and, more importantly, why.

Many investors may still feel that leaving their investments in bank accounts may be the best option to take, from a security and risk perspective. However, Stratfordians will remember the Icelandic Bank debacle, along with the near collapse of Northern Rock and other banking institutions in the UK.

The problem with bank accounts is simply that the returns currently offered by most institutions will most likely not even cover the effect of inflation, meaning that in the future, it won’t be possible to buy what you can today. That’s not good.

Making matters worse for the economy is the simple fact that consumer spending has not recovered. Most of us seem to be hanging onto our cash in case something dreadful happens, such as redundancy.

It’s also important to remember that deposits in bank accounts can be lost, and that this has happened before. Should the bank where you have your account go bust and be unable to repay your deposit, whilst all is not lost, your deposit will only be guaranteed by the Financial Services Compensation Scheme to a maximum of £85,000 per eligible claimant, per institution. This amount also includes any accrued but as yet unpaid interest returns.

Over the past few days, global equity markets have suffered significant falls. This provides a very painful reminder of what investment risk is all about.

Equity markets were fairly priced before this started. Now they are cheap. However, investing isn’t about buying a bargain; it’s about building an appropriate diversified portfolio, and holding it for its term. Anything else is gambling, and I’m sure we all know just how risky that can be!

Investors simply need to decide on the level of risk they are prepared to accept, balanced with the objectives they’d like to achieve with their money. Not falling-off-a-log easy, but then again, with the right advice, not impossible by any means.

Leave the gambling to others.

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