General discussion of investment risks
We have already discussed the nature of the stock market and the fact that it is at best a very volatile environment most of the time. It will be wrong to overplay volatility of share prices and to make this out to be the major investment risk of stock markets.
Volatility is a risk that has to be dealt with and there are strategies that can be followed to effectively deal with volatility risk and to manage it down to an acceptable level. Volatility is more of a concern for short-term traders with a short time horizon and they run the risk of permanent loss of capital at times. Traders are aware of this and accept up front that they will lose money at times and have strategies to deal with this. One would be to cut their losses quickly. Short-term trading is however beyond the scope of Phoenixclub and readers will have to access other sources for information. Long-term investors follow different risk management strategies and the risk of a permanent loss of capital is greatly reduced. Long-term investors will rather view volatility as an opportunity to buy shares of great companies at a discount while others are panicking.
There are many investment risks other than volatility and readers should be aware of them. These will be discussed in varying degrees of detail. Some are so obvious that they only need to be recorded for the sake of completeness. Many persons are however caught by these despite the fact that they are so obvious, and readers are urged to be very cautious. Below follows a brief discussion of the more common investment risks;
- Longevity risk: People are generally living much longer nowadays. A person who retires at the age of 60 may easily live another 30 years. Person who live long have a great risk of running out of money.
- The risk of ones investment returns not beating inflation. This risk is probably a greater risk than volatility. Unlike a sudden increase in interest rates, there is nothing to alert one to this danger. Inflation is gradually and systematically eroding the buying power of one’s money over time. Persons still earning an income and building a nest egg and their investments not beating inflation, will discover that they are not financially getting ahead. Persons who have retired and are living off income from one’s investments, will discover when it is too late that their investments have been eroded to the point where their capital is no longer able to sustain their lifestyle. The challenge, and this is an absolute must, is that your investments should grow at a rate much higher than inflation. The only way to beat inflation is to invest in growth assets and readers should not avoid risk at the cost of protecting their wealth against inflation.
- Sudden increase in interest rates while the household budget is overcommitted with a lot of debt (housing bond, vehicle hire purchase, credit cards, etc.). This has happened to many persons in the past and sudden huge increase in interest rates can and will happen again in the future. Readers should note the dangers of an overstretched budget as this has resulted in permanent loss of capital for many persons over time.
- Not planning for the long term. There comes a time in the life of most people when they will stop earning a salary or income of some sort and will start living from the income generated by their investments. For most people this means retirement. A common mistake made by many is to have their accumulated pension monies paid out every time they change to a different job. The consequences are normally very sad.
- Lack of knowledge – not being knowledgeable about investing in shares. We encourage persons to get a lot more involved in their financial wellbeing. If however you do not know have the required knowledge about investing and do not have the time to study and acquire the knowledge and to do research, then rather leave your investments in shares over to professionals.
- A get rich quick approach to the stock market and trying to play the market. Long-term investing is actually a bit boring. Actively seeking out the shares of volatile, quick growing small companies and trading these with a short time horizon is a lot more risky than long-term investing. Excitement and a rush of adrenalin is a sure indication of persons taking on too much risk and this can result in permanent loss of capital.
- Poor work ethic – being lazy and rather listen and react to “hot tips” from someone with so called inside information instead of doing their homework
- Investment scams – the too good to be true. Many persons have fallen prey to these unscrupulous people who devise these schemes and many more will become victims in the future.
Very important is that investors are aware of all the investment risks and to actively manage their risks. There are many approaches and strategies available to long-term investors to contain and manage investment risks down to acceptable levels to protect their capital from permanent loss and to achieve real wealth creation.
Risk and risk management are vital to successful investing and the strategies available to long-term investors are discussed in detail elsewhere on this website.
“Risk comes from not knowing what you’re doing.”