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Redefining Risk

Why “safe” investments might be the riskiest of all

Warren Buffett says, “Risk is not knowing what you are doing.” Again, the key word is you, not the investment.

I define risk as: Reckless Investing Sans Knowledge

For instance, my friend Tom Weissenborn, who’s a stockbroker, offers this rule when it comes to investing in stocks: If you don’t understand how the company makes money, then don’t invest in it.

As always, if it looks too good to be true, then it probably is.

What appears safe may very well be risky…very risky

Safe or risky? Those words need to be redefined when it comes to investing. Here are three places you can “invest” your money that typical financial advisers have advocated as safe.

1. Savings
2. Mutual funds
3. 401(k)s

Are these safe or risky? The typical financial planner will tell you they are safe. I say they are risky. Why?

Savings

With the dollar and other global currencies decreasing in value, your currency is worth less and will buy you less in the future. On top of that, the interest you are paid by the bank for your savings may earn you less than the fees and expenses you have to pay to keep your money in the bank. By saving money, in many cases, you are losing money. Would you call that a safe investment or a risky investment? An investment that consistently loses money is a liability.

Mutual funds and 401(k) plans

A mutual fund is simply a collection of stocks, bonds, and other similar securities. It could also be a company that pools the money collected from many investors and then invests those funds in stocks, bonds, and other similar paper assets.

A 401(k) is a retirement plan, often considered a retirement savings plan, set up by employers that allows employees to contribute a portion of their salary into this plan. A 401(k) plan invests the employee’s contribution into mutual funds. Similar plans exist in other countries under other names such as a superannuation plan in Australia and New Zealand, an RRSP in Canada, a 401(k) in Japan, and a pension scheme in the United Kingdom.

Here is the reality of mutual funds according to John C. Bogle, the founder and CEO of Vanguard Group:

Well, it’s awesome. Let me give you a little longer-term example I use in my book of an individual who is 20 years old today starting to accumulate for retirement. That person has about 45 years to go before retirement—20 to 65—and then, if you believe the actuarial tables, another 20 years to go before death mercifully brings his or her life to a close. So that’s 65 years of investing. If you invest $1,000 at the beginning of that time and earn 8 percent, that $1,000 will grow in that 65-year period to around $140,000.

Now, the financial system—the mutual fund system, in this case—will take about 2.5 percentage points [in fees] out of that return, so you will have a gross return of 8 percent, a net return of 5.5 percent, and [in that 65-year period] your $1,000 will [instead] grow to approximately $30,000. $110,000 goes to the financial system, and $30,000 to you, the investor. Think about that. That means the financial system put up zero percent of the capital, took zero percent of the risk, and got almost 80 percent of the return. And you, the investor in this long time period, an investment lifetime, put up 100 percent of the capital, took 100 percent of the risk, and got only about 20 percent of the return. That is a financial system that is failing investors because of those costs [fees] of financial advice and brokerage, some hidden, some out in plain sight, that investors face today. So the system has to be fixed.

The mutual fund companies, the managers, and the salespeople—they all make money whether you do or not. Most are not concerned with the actual performance of the fund. They are mainly concerned about their fees.

Now ask yourself, is that safe or risky? I call it risky.

Risky versus Safe

In the world of investing, there are no investments that are 100 percent guaranteed. There is no investment that is absolutely safe (safe meaning “free from losses”). There is no risk-free investment. When you invest your money, you will win and you will lose. That is a guarantee. Yet there certainly are things you can do to reduce the risk and increase the safety.

In summary, what is risky and what is safer?

Risky

• Having no financial education.
• Blindly turning your money over to a financial planner or adviser.
• Not understanding the investment and the returns on the investment.
• Putting up the majority of the money and the risk and letting others walk away with the majority of the returns.
• Having no control in your investments.
• Depending heavily on a financial adviser.

Safe... er

 

• Getting financially educated.
• Actively investing your money and gaining hands-on experience.
• Understanding the investment and the returns on the investment.
• Putting up the majority of the money and the risk and getting the majority of returns.
• Having control in your investments.
• Becoming your own financial adviser.

 

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