Blogs | April 5, 2017

Relatively risky or safe as houses? Juggle investments wisely

Context is critical when deciding how to spread investment risk, says Chris Dillow

There’s no truly safe place to put your money. Deposits with even the strongest and best-insured banks expose you to inflation risk – the danger that your money will lose value as prices rise – as well as reinvestment risk – the possibility that interest rates will fall even further.

Even the safest bonds also face inflation risk. And the price of gold fluctuates a lot. The only truly safe asset is an inflation-proofed bond that matures when you need the money.

This isn’t terribly useful. Most of us don’t know when we’ll need cash: when will we lose our job? When will our car finally pack up? And even if you do know you’ll need money on a particular day, index-linked bonds merely guarantee that you’ll lose money because – in the UK at least – they offer negative real yields.

Take your pick
It might appear, then, that all assets are risky. Not quite. Let’s remember a key principle of investing, one that’s often forgotten: what matters is your portfolio as a whole. We must consider all our assets and all our sources of income. If we do this, we can see that some people do have safer assets.

For example, those who have retired on inflation-linked pensions have a more secure source of income. A job can also be a relatively safe asset: your human capital can be a form of wealth as much as your financial assets.

Even for the rest of us there are some safer assets, if we think of them in the context of an overall portfolio. Bonds, for example, are like car insurance. Both will probably lose you money. But both will probably pay out in the event of a crash – be it a car crash or a stock market crash.

Remember a key principle of investing, one that’s often forgotten: what matters is your portfolio as a whole.

Compare or contrast
Viewed in isolation, car insurance and bonds look like bad ideas. But compared to other assets, they don’t. Buying car insurance is daft if you don’t have a car, but is usually sensible if you do.

Likewise, bonds may look like bad investments in themselves, but make sense as insurance against some stock market falls. The same is true for bank deposits. These protect us against the possibility that shares and bonds will both fall.

And this possibility isn’t to be ruled out. If US inflation rises by more than expected, prompting the Federal Reserve to raise interest rates, bonds and shares might both do badly. Likewise, although gold is a volatile asset in itself, it can help spread risk. It could do well in the event of serious political trouble, or rising world inflation, or if global real interest rates fall even further.

For investors, foreign currency can also be a safe asset. Currencies tend to fall during financial crises – because investors regard them as a risky asset and dump them when they get nervous. Other currencies may tend to rise while house prices in one country fall. This means they can be a form of insurance.

Safer for some
UK housing, for example, is a relatively safe asset for some people. Wealthy Russian and middle-eastern investors have bought London property for years, regarding it as a possible safe haven. Some see ownership of foreign property as giving them somewhere to flee if the political climate at home turns against them.

Quite simply, few assets are entirely safe in themselves, and none offer both safety and a decent return. Many, however, may offer a rough and ready partial insurance against certain risks. A reasonable degree of security can therefore be achieved by diversifying. Sometimes, the clichés are right: don’t put all your eggs in one basket.

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Chris Dillow
Chris Dillow

Investors Chronicle writer and economist