How often do you hear people saying things like - that's risky or this is safe, in relation to investing?
Before we start, it's important to emphasise that I'm talking about investing here, which means a process of an ongoing long-term value enhancement, not parking your money in for your next year's ski trip. That's called saving.
Volatility does not equal risk. It's there for that same reason - to leave us with some returns after inflation and taxes.
If you got to this end of the article, you've just learned three very important (although counter cultural) facts:
- inflation is the reason why people invest
- shares can be safe if they're invested for the right reason
- volatility doesn't mean risk if you process it correctly
The very concept of both is very subjective and it depends on people's points of view, their attitudes, their experiences but predominantly their practical understanding of value of money.
When it comes to investing, the words like safe and risky are being used so loosely (by both the advice professionals and the general public) it's created a confusion costing you big time!
That's why I thought it was about time I set the record straight.
That's why I thought it was about time I set the record straight.
Firstly, let's define what the real value of money is - the actual ability to pay for things we value. It has a name - the purchasing power and it simply represents what we can buy with our money.
Still with me?
Still with me?
Question - What happens to the purchasing power as the cost of living constantly increases?
The value we get for our money decreases. The value of our money is being constantly eroded by the increasing cost of living (inflation).
Now, if the above is true, we're kind of stuck with the assumption that the only risk, when it comes to investing, is inability to enhance the purchasing power of our money at a higher rate than the cost of living is going up.
The value we get for our money decreases. The value of our money is being constantly eroded by the increasing cost of living (inflation).
Now, if the above is true, we're kind of stuck with the assumption that the only risk, when it comes to investing, is inability to enhance the purchasing power of our money at a higher rate than the cost of living is going up.
That's a big statement, you might want to read that one again.
Ok, let me ask you a question. What's the real inflation rate in Australia - you know, the rate at which stuff we pay for on a daily/weekly/monthly basis - milk, petrol, private health insurance, electricity...) goes up?
The real inflation is more like 5-6% pa.
Looks like now we're getting somewhere. Let me ask you another question. What do you think is the only type of asset with ability to produce ANY returns after inflation and taxes?
The correct answer is equities / shares / stocks / companies !!!
Whaaaaat?! Shocked? It's very counter cultural and counter intuitive thing to write!
That would mean that (after inflation and taxes) it's the shares which are safe in the long run! Hmm, and chances are that (until about five minutes ago) you thought it was the other way around - that it's cash that's safe and the shares are risky!
Whaaaaat?! Shocked? It's very counter cultural and counter intuitive thing to write!
That would mean that (after inflation and taxes) it's the shares which are safe in the long run! Hmm, and chances are that (until about five minutes ago) you thought it was the other way around - that it's cash that's safe and the shares are risky!
What this means, is that if we want to start creating real wealth, in real life (which includes inflation) and keep our money safe ,we need to expose it to shares.
The higher the exposure to shares, the higher the probability (approaching certainty over time) that we'll successfully manage to keep our money safe.
The higher the allocation to cash, term deposits and bonds, the higher the probability (approaching certainty over time) that we'll in fact fail to keep our money safe and as a result our money will lose value over time.
And you thought it was the other way around, didn't you? The cash is king, keep your money safe, shares are risky, it's the last place I'll put my money in, I don't want to lose it .... blah blah blah... People repeat this to themselves and they don't even realise how irational it sounds.
They keep fighting the dragon of losing the their capital and the real dragon of inflation comes through the back door, totally unannounced to them, unobserved by them and destroys them.
Losing the capital while investing in shares, when you invest over a long term, is virtually impossible.
And that completes the tragedy of this flawed concept of risk. People are actually fighting a dragon that doesn't even exist. We don't have a 20 or 30 year period in the history of our share market when equities even produced a negative return.
And what's this 'long term' everyone refers to? How long do we invest for? Let me answer you with a question - When will the inflation stop?
One more thing, the equity/share/stock investing comes with the ups and downs - the volatility. But hey, that's the exact reason why you're getting the premium average return of 2-3 times the inflation rate.
And what's this 'long term' everyone refers to? How long do we invest for? Let me answer you with a question - When will the inflation stop?
Volatility does not equal risk. It's there for that same reason - to leave us with some returns after inflation and taxes.
If you got to this end of the article, you've just learned three very important (although counter cultural) facts:
- inflation is the reason why people invest
- shares can be safe if they're invested for the right reason
- volatility doesn't mean risk if you process it correctly
Don't let anyone else tell you otherwise. The traditional understanding of risk - the higher the risk, the higher the return - isn't really accurate, I'm sorry.
The more accurate version is this - the higher the required return, the higher volatility.
It's how you deal with volatility, how you process it, how your mind moves when you experience it and how you hire someone to help you deal with it - that's what really matters!
If you want to find out more about real investing - click here for my Hitchhiker's Guide to Investing series.
What's your view? Can't cope with volatility? Want to find out more on the topic of equity investing?
Drop me a line to mbodi@sydneyfinancialplanning.com.au or simply comment on this article.
The more accurate version is this - the higher the required return, the higher volatility.
It's how you deal with volatility, how you process it, how your mind moves when you experience it and how you hire someone to help you deal with it - that's what really matters!
If you want to find out more about real investing - click here for my Hitchhiker's Guide to Investing series.
What's your view? Can't cope with volatility? Want to find out more on the topic of equity investing?
Drop me a line to mbodi@sydneyfinancialplanning.com.au or simply comment on this article.
Also feel free to google my name for more information on investing and money behaviour.
Catchya,
Michal 'Misho' Bodi