When it comes to investing, you can’t break the relationship between risk and return – it’s always there even if you can’t perceive it.
The word ‘risk’ is hard to explain as its subjective, vague and emotive.
I’ve found the following stories which I think explains the three risks of investment really well. (Source: Andy Hart, Financial Advisor and Founder of Maven Money)
The ‘rollercoaster’ risk
This is the risk that people tend to think about when they’re investing and potentially the least worrisome of them all.
A rollercoaster sets off from its platform and gathers momentum for the ups and downs that ensue, before returning to the start. This is an analogy of the volatility an investor experiences.
Investment in the stock market will go up and down, but providing you sit still and remain invested, you’re going to get back to where you started. In fact, the reward for accepting the rollercoaster ride and associated volatility, could over time, result in better returns for a well-diversified and well-managed portfolio.
It’s also worth remembering rollercoasters are only dangerous if you try to get out at the exciting bit.
The ‘ice swan’ risk
Imagine you’re going to a wedding. When you arrive, there’s a beautiful ice swan centrepiece. You take a moment to admire the intricate detail and whilst you look at it, it doesn’t change.
You continue the afternoon amongst family and friends. When you come back to the sculpture, it looks slightly different to earlier, but still remains the same when you look at it.
You leave the sculpture once again and when you come back at the end of the night, you find a block of ice and a puddle on the floor – it is ice after all! It remains an object which doesn’t change in that specific moment, but you know it has ultimately changed from when you first walked in.
This is an analogy for inflation. You can keep looking at money in a bank account and it won’t change, however, over time, its value is being eroded by inflation – something we know all too well in the current climate of rising prices.
The opportunities presented by the rollercoaster and associated volatility can help combat this risk.
The ‘turkey farm’ risk
This is potentially the biggest risk of all and one to take heed of.
Think of yourself as a turkey, living your best life on a free-range farm, alongside other fellow turkeys, with as much to eat as you could possibly want.
One morning, you wake up and there’s a nervous tension on the farm. Your friends are disappearing out of the field, one by one. It’s now the month of December and life as you know it has very quickly shifted from fantastic to catastrophic.
This is an analogy for investments. In a rising stock market, you have an investment which is performing particularly well. You feel pleased, perhaps even over-confident with the direction its going. Then, one day you lose it all.
This is a catastrophic risk, one which can be potentially avoided by holding a well-diversified and well-managed portfolio.
This blog is intended as an informative piece and does not construe advice. If you have any further questions or would like to discuss your financial planning needs, please don’t hesitate to get in touch with us using the form below or by reaching out to your usual Equilibrium contact.