How Safe Are My Investments?

Investing in shares of companies can be a lucrative way to build wealth over the long-term, but it’s important to be aware of the risks involved. Recently, a Democrafy subscriber raised a question about the safety of his investments. In this post, we’ll delve into the various risks involved in investing, and all the perks that come with it. We’ll also consider whether the investment platform itself is trustworthy.

INVESTMENT RISKS

Investing in a portfolio of shares comes with several risks. For starters, the shares you hold can fluctuate in value. While short-term changes in value shouldn’t matter if you plan to hold your shares over several decades, investors often place too much emphasis on them, leading to emotional decision-making. This can result in overconfidence and extreme risk-taking when markets rise, or a sense of panic when they fall, leading to selling at the worst possible time.

Another risk is that the value of what you own may perform worse than the overall market. For example, if you only hold tech shares, and they fall in value, you risk underperforming the market. For most investors, investing in a diversified basket of shares via a global index fund or ETF is the easiest way to mitigate this risk.

Finally, there’s the risk of making poor investment decisions due to lack of knowledge or overconfidence. This is another reason why it makes sense to own a diversified basket of shares – to protect us from our own worst enemy – ourselves. Don’t blindly go chasing the ‘next Tesla’. It’s like playing darts while blindfolded – sure, you might hit a bullseye once in a while, but more often than not you’re going to miss the board entirely. For every company that looked like Tesla at the time, there will be dozens that never survived. You may have made substantial gains on Tesla, but you’re just as likely to have made substantial losses on your other positions. Looking back, it seems obvious, but looking forwards it’s difficult to predict. If it’s tough enough for the pros spending 50 hours per week on this, it’s probably not something you can do for a couple of hours at the weekend by reading the news. Unless you have a crystal ball.

PLATFORM RISKS

Investment platforms are different to banks. When you deposit money in a bank, your assets are sitting on their balance sheet. If the bank goes bust, you risk losing your deposits, except for the government FSCS guarantee of £85,000. On the other hand, investment accounts, like an ISA (Individual Savings Account), SIPP (Self-Invested Pension Plan) or GIA (General Investment Account), hold your investment assets in an account, not on balance sheet. As such, if for any reason the investment platform goes out of business, your accounts are segregated, and can be moved to another investment platform without loss.

It is always possible that fraud can happen. But the purpose of regulation is exactly to prevent this mismanagement. Although there is always a chance of an investment platform stealing your assets, it’s a slim possibility. If you were concerned about this, you could choose to use two or three investment platforms to help you sleep at night. The reality, however, is that you’re far more likely to lose money from your choice of investments than from your choice of platform. Just don’t give your money to a shady website with neon signs saying, ‘INVEST HERE’.

ADVANTAGES OF INVESTING – SAFETY IS RELATIVE

Despite the risks involved, investing has numerous benefits. Over the long-term, investing in a diversified basket of companies typically delivers is a sensible strategy for most people. As the economy grows, with some inflation, strong companies benefit by selling more and gradually raising prices. Their returns are reinvested in the business to generate future growth, or returned to shareholders in the form of dividends, or share buybacks.

Investing is the best way to build wealth and take advantage of the power of compounding. The compounding effects can be significant, and by not investing you are effectively guaranteeing a loss:

SCENARIO 1: Take £10,000, earning 2%/year for 40 years in a current account. Result: £22,000.

SCENARIO 2: Take £10,000, earning an average of 7%/year for 40 years in a portfolio of shares. Result: £150,000.

At first glance, Scenario 1 has doubled your money. But you’re actually 85% worse off than you would have been under Scenario 2. So by choosing to keep your money in a bank account, you’re locking in a loss of 85%, compared to what you could have had by investing. That’s food for thought…

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In investing, there’s always a degree of risk. But if we do nothing at the first sign of a risk, we’ll never reap the rewards. A better approach is to understand that safety is relative. We can’t be entirely safe, but we can take actions to mitigate risk. These include:

• Investing for the long-run

• Being in control of your emotions

• Having sufficient diversification

• Avoiding speculation

• Holding investment assets with a regulated and reputable investment platform

And by using compounding to our advantage, we can mitigate arguably the biggest risk – namely, not taking any action at all. Investing offers the largest opportunity to make your money work for you. It’s a rare case in life where one idea, taken seriously, can generate sensational results. Go and use it!