Risk

HappyHarry

Risk is a fascinating area. An individual's risk level is not possible to quantify exactly, despite there being many "risk questionnaires" that attempt to do so. At the same time, it is easy to quantify the risk, or volatility of an investment, through historical data.

In theory, as the OP implies, any right-minded individual should quite happily accept the occasional 40%+ drop in the value of their investments, safe in the knowledge that a diversified equity portfolio will recover and gain over the long-term. Providing, of course, that the long-term is available to the individual.

However, individuals have emotions, and these interfere with logical progression. I have many clients to whom a 40% drop in the value of their investments would be terrifying. Even some of the younger ones who have a long-term investment horizon. I imagine some of those clients facing such losses would sack me as their adviser, and may even raise a complaint against me and make a successful demand for compensation, even though such investments are likely to be beneficial for them in the long-term.

I have met many people who invested in something, saw the value drop over the short-term, sold the investment at a loss, and be put off investing again. I have had conversations with people where I have pointed out that these investments had then recovered, and had the person remained invested, would have made a handsome profit. Often these people still do not want to invest again, contrary to all logical expectation.

The posters on these boards (Savings & Investments / Pensions) generally appear to have a higher risk tolerance than the clients I meet. I suspect this partly because a large number of these posters are experienced investors, who have less emotional attachment about short-term volatility than the average person, due to their experience and understanding of the nature of investing. Partly, of course, this is due to posters that have no clue about long-term investing, and instead want to shout about the latest / greatest get-rich quick scheme, which are inevitably very high-risk endeavours.

Another poster above suggests that IFAs / FAs like risk conversations because it allows advisers to defend underperformance of investments. That is not true. Advisers compare the investment returns against an appropriate risk-rated benchmark. If the funds had underperformed, then the adviser should be able to justify why, and be able to explain what, if anything, should be done about it. 

In answer to the OP's question "are those who truly believe in the principles above really actually taking a “risk” at all?" then no, they are not really.  However, deep down, the majority of people do not really believe in these principles.

sevenhills

HappyHarry said:

Risk is a fascinating area. An individual's risk level is not possible to quantify exactly, despite there being many "risk questionnaires" that attempt to do so. At the same time, it is easy to quantify the risk, or volatility of an investment, through historical data.

Surely if a profit is likely more than 50% of the time, then the risk is a good one, but not everyone can afford a loss. There is no bookmaker making a handsome profit, just perhaps 0.5% by the platform.

dunstonh

I have met many people who invested in something, saw the value drop over the short-term, sold the investment at a loss, and be put off investing again. I have had conversations with people where I have pointed out that these investments had then recovered, and had the person remained invested, would have made a handsome profit. Often these people still do not want to invest again, contrary to all logical expectation.

I've said it before on here that those that say they lost money on the stockmarket and will never do it again, do so as they invested above their risk profile and level of knowledge and understanding.      

The posters on these boards (Savings & Investments / Pensions) generally appear to have a higher risk tolerance than the clients I meet.

We have seen threads on here were someone is undecided for weeks and months about investing. Says they can handle the risk but just can't decide. Gets the usual DIY high-risk recommendations and then when it falls 1% in the first two weeks, they are back on the board asking if they should pull out as they didn't think it would lose money so early on.

I have found that a larger number of new DIY investors tend to invest higher risk than they should.  Usually without realising there are doing so.   Often based on what they have read as being promoted recommended in the press.     The media does like focusing on specialist/high-risk funds.

 

HappyHarry

sevenhills said:

HappyHarry said:

Risk is a fascinating area. An individual's risk level is not possible to quantify exactly, despite there being many "risk questionnaires" that attempt to do so. At the same time, it is easy to quantify the risk, or volatility of an investment, through historical data.

Surely if a profit is likely more than 50% of the time, then the risk is a good one, but not everyone can afford a loss. There is no bookmaker making a handsome profit, just perhaps 0.5% by the platform.

The vast majority of index and managed funds have more than a 50% likelihood of profit over the long-term. That doesn't mean that a global index tracker and a 40/60 cautious managed fund are both ideal for everyone, despite their long-term positive expectations.

Linton

sevenhills said:

HappyHarry said:

Risk is a fascinating area. An individual's risk level is not possible to quantify exactly, despite there being many "risk questionnaires" that attempt to do so. At the same time, it is easy to quantify the risk, or volatility of an investment, through historical data.

Surely if a profit is likely more than 50% of the time, then the risk is a good one, but not everyone can afford a loss. There is no bookmaker making a handsome profit, just perhaps 0.5% by the platform.

You need to compare the effect of success and failure.  I would not be prepared to bet my house even with a 90% chance of a large profit.  That is why serious investing needs an objective which is important to the investor.  Only then can you make a rational decision as to whether a risk is a good one.

I suspect many posters on this forum have an at least moderately safe income and are either playing at investing or are in the early stages of accumulation for retirement.  If they win, great, if they fail it does not matter much.  For those in such a position maximum returns are the only yardstick by which investing strategies can be assessed.

The situation is very different if one's investments form a major part of one's worldly wealth.  Any risk worth taking must be judged at far less than a 50% chance of a failure resulting in significant loss.  Indeed, it is worth spending money to reduce the risks that external events may present.

Albermarle

I think 'Loss Aversion'  plays a big part in many peoples view of money and life in general.
Loss aversion is the tendency to prefer avoiding losses to acquiring equivalent gains. 

Linton

Albermarle said:

I think 'Loss Aversion'  plays a big part in many peoples view of money and life in general.
Loss aversion is the tendency to prefer avoiding losses to acquiring equivalent gains. 

It seems to me a perfectly rational tendency: iI you are broadly satisfied with your financial position acquiring £X more than you  need doesnt balance having £X less than you need in the happiness stakes.

LHW99

Risk is the probability that an investment could see a permanent loss in capital value

Or perhaps sees a loss in value at the point where you really, really need to cash it in. IMO many of the general population find probabilities hard to assess, otherwise I suspect lotteries would make rather less profit.

Malthusian

NorthernJoe said:

Yes, I know it is about behaviours & that when experiencing a loss of 40%, those with a “low risk” tolerance will bail out and solidify their loses. Again however this surely more about beliefs – those who believe that past performance is indeed indicative of future results & that in the long-term, a well-diversified portfolio will generate significant returns will probably buy even more assets if they can in a downturn.

Which past performance are you thinking of? The past performance of 2000-2006 and 2008-2013, when diversified investments crashed and eventually recovered? Or the past performance of the last few months in the current downturn, where all holding on has achieved is to make your investments fall even more?

A lot of people assume that past performance is a guide to the future and therefore cash out their investments before they lose even more money.

As for the past performance of previous crashes and recoveries, that is written off because "this time is different".

In March 2020 I saw even experienced IFAs claim that this crash wasn't like the previous ones because the previous crashes didn't take place in a global pandemic. Likewise in 2008 people were claiming that this crash wasn't like the previous ones because we were facing a recession that would last a decade or more as the debt bubble unwound.

In the next crash, whenever it is, lots of experts and amateurs will once again be claiming that this time is different and you should sell everything and hold what you have before it gets any worse.

As for not just holding on to existing investments in the middle of a crash but investing more money, that essentially requires you to be a psychopath. I believe that's the medically or at least socially accepted term for people who don't allow the feelings of everyone around them to affect how they feel.

HappyHarry said:

I have met many people who invested in something, saw the value drop over the short-term, sold the investment at a loss, and be put off investing again. I have had conversations with people where I have pointed out that these investments had then recovered, and had the person remained invested, would have made a handsome profit. Often these people still do not want to invest again, contrary to all logical expectation.

Not really. If they did reinvest, what would be different that meant they wouldn't cash in again the very next time the markets crashed? "Look what happened in 2020" won't stop them cashing in because by the time the next crash happens, that could be ten years ago, and it'll be no different to "Look what happened in 2008-2013" in their first go-round.

Their brains are still wired in exactly the same way they were when they cashed in at a loss. It is entirely logical for them not to want to invest money when they know they don't have the mindset for it.

MaxiRobriguez

Malthusian said:

As for not just holding on to existing investments in the middle of a crash but investing more money, that essentially requires you to be a psychopath.

I've got a hockey mask I like to wear out at night to scare people with and I doubled down in March so the theory holds.