Quite a while ago I was asked this question, “I am new to investing but I am risk adverse. Is there a risk-less investment that I can go into?”
I could not remember the answer that I gave in verbatim, but I would give a general gist here. If you had asked the above question before, hope this post would give you some clarifications. I tend to be a little bit long-winded and go a bit out of point, but I would prefer to explain some stuff on a holistic basis.
What is Risk?
Risk is a possibility of anyone, anything or any situation that may inflict harm, injury or loss. The key word here is possibility, or what academics called probability. Though you may not be aware, but we face risks all the time. The main reason why we do not take these everyday risks into serious consideration is due to its low probability in happening, and/or we have taken steps in reducing that possibility.
For example, a simple act of crossing the road involves many risks, such as; the risk of tripping while crossing, the risk of a vehicle impacting you, the risk of a sinkhole forming on the road and devour you, etc. OK touch wood.
Investment Risks and Diversification
In The Bedokian Portfolio ebook, I had listed down a number of risks related to each asset class, including the all-encompassing volatility risk. In fact, for all the investment risks that I had noted, the main thing about them was the loss of profit and/or loss of capital. Yes, it was this simple.
Investment risks are part and parcel of investing, and there is no escape from them, so we would need to manage these risks. By managing them, you could reduce risks and prevent huge losses to your investments. For the simple investor, the main way to do so would be diversification of the asset classes, followed by regions/countries and industries/sectors. What we are banking on is the different correlations existing between the things being diversified, which is proven in numerous studies and historical examples.
So, Is There A Risk-Less Investment?
Yes, I remembered that question popped up in the middle of our talk, and my flat answer to him was a big “NO”.
Remember, risk is about probability, and some forms of investments are labelled as risk-less is probably due to two reasons; firstly, the very low probability of risk happening and secondly, it could be the various perceptions of risk by different individuals on the same investment.
Using government bonds as an example, the probability of a default is very low, hence proving the first reason in the previous paragraph. For the second point, many people tend to view exclusively the almost non-default of government bonds and called it risk-less, but they probably did not see the other risks that come with all bonds, such as reinvestment and rate risks.
And If You Do Nothing
The most powerful, yet almost unseen risk of all would be coming if totally no investment is done, not even on bank interests. Yes, you have guessed it, that risk is inflation. I recalled that I used this risk as my parting shot in my conversation, and that jolted him a bit.
So what is the moral of this story? Keep invested to secure your future.