Safe Isn’t

Safety is not the opposite of risk.  Realistically, they are barely connected.  Making the equation that safety = not risky, leads to serious problems with financial outcomes.

Okay, why?

Safety is a security idea.  In terms of money it means I  have and will have enough to meet my needs.  The conditions that imperil that idea are typically called risks.  Not all of them are perils.  Some that look like danger are in fact opportunities if all the variables are assessed fully.

Risk is a catch all term in investing.  Most commonly it means that the price of a particular security or portfolio has been variable.  The value is created mathematically and risk is the standard deviation of rates of return at one year intervals.  A security that averages 8% returns but has produced everything from -20% to plus 30% is “risky.”  Risky in this form means the price is unpredictable.

Try to avoid being caught up in the “unpredictable at one year intervals” idea.  For most investors the one year horizon is irrelevant.  If you study stock markets over long periods you find that as time increases the standard deviation falls.  The long run is much more stable than the short run.  If you are investing for the long run, why should you care about a short run statistical anomaly?

The flight to safety does not reduce risk.  Typically bonds are more stable in the short run than is the stock market.  As the price for that, you accept lower returns.  Bond markets are less stable than stock markets over long periods.  If you have a long time horizon, bonds are less safe.  Lower returns, especially if you consider taxes and inflation, and less predictability.

Most people think of risk as getting back less than they put in.  We know that can happen in the stock market.  Sometimes spectacularly.  The variability idea does not deal with that kind of risk.  That kind of risk is a business characteristic.  If it is a good business, in a good industry and with competent management, then that risk is quite low.

Under the variability idea, a security that falls exactly 5% every year is riskless.  No variability. That certain loss can be without investment risk seems wrong.

Investment safety is achieved by effort and research and skill and patience.  Participate in good businesses.  Hold some cash to take advantage of Mr. Market when he undervalues good businesses.  Sell to him when he overvalues something.

Even with all of that, there will be days when you will have losses if you believe that the market price has meaning.  The price has no meaning unless you sell.  It is just the average opinion of people transacting sales today. 

People can easily become confused if they look at “an opinion of value” and then analyze the non-fact answers using statistical methods that are irrelevant for their situation.

The price of a stock tells you more about how people think than it will tell you about the value of the business.

Safety is the result of knowledge and wisdom applied continuously for a long time.  Avoiding “investment risk” will likely hurt you.

Contact: don@moneyfyi.com  

Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

This entry was posted in Investing, Personal Finance and tagged , , , . Bookmark the permalink.

2 Responses to Safe Isn’t

  1. What helped it click for us was a Vanguard article that said, basically: if you avoid investing money in variable funds for fear of losing value, you’re actually guaranteeing a loss of value, since savings accounts do not pay enough interest to keep pace with inflation. So, in truth, everything is a risk! Might as well take the smarter risks.

  2. Pingback: Out-Thinking Risk | moneyFYI

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