It’s safe to go back in the water
Coconuts versus sharks! Dr Ben Holdsworth on why we struggle to get investment risks in perspective.
If you have ever been fortunate enough to swim on Bondi Beach among the surfers, or in the chilly waters of Cape May – where the film Jaws was filmed – in the back of your mind may have lurked the thought that a large shark might just be out there looking for lunch. What was that shadow?
Yet most of us do not think twice about the risks of sitting under a coconut tree, which is far more likely to kill you from a falling coconut, as is the malaria-carrying mosquito that lands on bare flesh as the sun sets in paradise.
Nor did we consider the risk of a deep vein thrombosis from the long-haul flight we took to get there. We fixate on the shark.
Humans are irrational and find it hard to place risks in perspective, in part because they involve numbers – which many people hate – are influenced by fear or recent news and often depend on the way in which they are framed, to name just a few of the challenges.
We have a very clear recent example of our confusion with the extremely rare possible side-effects of some of the Covid-19 jabs.
Full of risks
Latest estimates suggest that the risk of dying from the vaccine due to blood clots is one in one million, which is similar to the chance of being murdered next month (nasty) or dying in a road accident on a 250-mile road trip.
Life is full of risks and those that we deem to be everyday consequences of modern life, we take, usually without batting an eyelid, such as: driving, using ladders, drinking alcohol, climbing mountains and walking through fields of cows – nearly 100 people were killed by cows between 2000 to 2020. Yet other exceptionally low risks we deem ‘too big’ to take.
It is similar with investing. Investors tend to worry about equity market crashes, perhaps not surprisingly, as equity markets can and have fallen by more than 50 % in the past.
Yet owners of equities should not be looking to sell them in the next few years but relying on fixed-income assets to meet liquidity needs.
Markets recover
In most cases, markets recover relatively quickly over, say, three to five years, sometimes more slowly. With horizons well beyond these falls and recoveries, investors who stay the course should be rewarded – as they have been in the past – with strong returns above inflation.
The latter is the real risk to long-term investors. Avoiding equity market risk and putting money on deposit is actually the risky strategy in some instances.
Of course, large falls in values can occur from time to time and such a fall may coincide with when you need your money. If you might need your money back in the short term, or if you rely on it, taking risk may not be appropriate.
There are also those who prefer security and would not sleep well seeing large fluctuations in value. However, for those who can tolerate risk and who are investing over a reasonable length of time, investing can work well.
Diversified approach
It is also important to note that some ‘individual’ company shares may not recover as we have seen with some of the firms disappearing from our high street. A diversified approach is critical, but the key point is that cash can carry its own risk.
Over the past ten years, those holding cash have lost around 1/5th or 20%, or £20 in every £100 of purchasing power, however you want to describe it. That is risky.
Managing risk in our lives is summed up well by Prof Dame Glynis Breakwell who wrote a book entitled The Psychology of Risk. ‘Risk surrounds and envelops us. Without understanding it, we risk everything and without capitalising on it, we gain nothing.’
Once we can get back to azure waters, brave the chance of sharks and stick with your equities. The risks will be worth it.
Dr Benjamin Holdsworth (right) is a director of Cavendish Medical, specialist financial planners.
The content of this article is for information only and must not be considered as financial advice. Cavendish Medical always recommends that you seek independent financial advice before making any financial decisions. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The value of investments and the income from them can fluctuate and investors may get back less than the amount invested.