Why Trying to Avoid Risk Can Be Risky
"All courses of action are risky, so prudence is not in avoiding danger (it’s impossible), but in calculating risk and acting decisively" (Niccolo Machiavelli)
This year has reminded everyone that investing comes with a large degree of risk. The Covid-19 crash in February and March was one of the most brutal in history.
Even though stock markets have largely recovered, there is still a lot of uncertainty out there. Is there now a bubble in tech stocks? Will the second coronavirus wave prolong the global recession? Can South Africa fix its economy?
Urge to act
In stressful times like this, many investors feel the need to “do something”. When things go wrong the natural desire is to want to act in order to fix it. Doing nothing seems indecisive, or even weak.
The problem, however, is that in these kinds of environments nobody knows what is going to happen next. Making rational choices is therefore impossible. The only way we can make decisions is if we are guided by something other than logic.
Almost invariably, what takes its place in these circumstances is emotion.
“Safe and sound”
When things are so unsettled, we naturally look for certainty and security. We want things to be predictable.
Unfortunately, this emotional need can lead to a compounding of poor investment decisions. Many people took their money out of the stock market when it crashed and put it into something else they believed was safer.
That means that they not only accepted the losses they had made, but they missed out on the recovery. If they put it in the bank, they are also now earning interest at the lowest interest rates that South Africa has seen for decades.
Everything has a risk
Keeping your savings in cash, however, is never a good idea over the long term. You will never grow your wealth if you are earning interest that is no higher than the inflation rate.
You also need to bear in mind that you will be taxed on any interest you earn above the threshold of R23 800 for someone under the age of 65 or R34 500 for anyone 65 or older. This will erode the actual return that you see even further.
It may feel like you have negated the risk of losing money in the short term, but over the long term you are guaranteeing that the value of your investment will decline. Inflation will erode it away.
The even greater danger, however, is that many people get seduced into one of the many scams that pop up at times like these. When there is so much uncertainty around, people offering “investments” with guaranteed returns and attractive interest rates are going to be everywhere.
Ask about the disadvantages
The time we are most vulnerable to these scams is when we are scared about the future, because that is when they appear to be offering what they most want. However, this is the time to be extra vigilant. The most important question to ask anyone promoting any financial solution now is: “what are the disadvantages?”
There is no such thing as an investment without any downside. Anyone who says that they have an investment with no disadvantages, or that is risk-free, either doesn’t understand investing or is lying.
Either way, investors shouldn’t trust them. They are making a sales pitch, not giving advice, and that means that they are looking after their own interests, not yours.
To talk about the level of risk that is appropriate for your investment needs, speak to your financial adviser.
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