“Medium Risk”

Q. What’s your attitude to investment risk?

A. Well, I, er, um, guess it is about mediumish. Er, was that the right answer?

Fair enough. What else are you going to say? You are not going to say “high” lest your financial advisor starts putting all your money into a Belgian ostrich farm and you are not going to say “low” because you don’t want to sound like a wimp or a paranoid nutter who keeps all his cash under the mattress.

But is it the right answer? Well, yes and no. “Medium” is going to mean different things to different people and it may not mean the same thing to your financial advisor as it means to you. It is not a very meaningful term. If your advisor is any good they will try to unpick what medium risk means for you and see what is suitable. If they are no good then they will just use its ambiguity to sell you whatever brings the most commission.

You may wonder why I am writing this? It all stems from an epiphany I had looking at an ISA statement last year. It wasn’t good news but what I did notice was that most of the high-risk investments I had felt brave in buying a few years back had done better, or at least no worse, than that medium risk ones. They had gone up more when things were good and fallen about the same when things turned bad leading to a better overall result.

Now I am not a financial advisor, far from it, but here are some random thoughts and experiences I have about financial risk.

  • People get too hung up on the risk level of each individual investment meeting their risk profile. If you are a medium risk investor then you want a mixture of low, medium and high risk investments that meets the overall objective.
  • Sometimes, with risk, 2+2=3. Diversification reduces overall risk. So long as your high risk investments are spread over the world and different sectors then it is hard for them all to get directly clobbered by whatever bad news is coming next. If you keep all your money in your home country (which is what most UK advisors will suggest for medium risk customers) then you expose yourself to the risk that your country will do badly compared to other countries.
  • Some types of investment only hide risk without eliminating it. This is no use at all and only makes things harder to understand. I am talking about “capital protected” products where the protection is not always as valuable as it looks and the charges are totally opaque.
  • Medium risk investments can often be the least compelling of all investments. Low and high risk investments are normally quite easy to understand and have reasonable charges. Medium risk investments are often bizarre hybrids with weird measures to reduce risk built in. These may or may not work but they definitely do add cost and complexity.

That might all sound a bit muddled but, pulling it all together, here is an alternative approach to medium risk investment. It is more or less the situation that I bumbled into without realising it:

  1. Put more than half your money in government guaranteed no-risk savings products. Try to get a reasonable interest rate but take no risks.
  2. Put the rest into a very broad portfolio of high and even very high risk investments. Don’t chuck it about brainlessly and don’t go for any scams but do spread your money round the world and across all asset classes where there is prospect for decent profits.

Let me explain the idea:

If the global economy does well then most of the high risk investments should do very well. If one or two of them go bad then the others will cover the losses and still outperform the stodgy medium risk investments by enough to give you a decent overall profit on half as much money invested.

If the global economy does badly then your high risk investments will get hammered but perhaps not as badly as you fear. Diversification will mean that at least a few of them will hit a niche that bucks the trend and helps offset the losses in the others. They key point is that you can’t lose more than 50% because more than half your money is in no-risk savings. With only half your money exposed, you might even find that you lose less in a serious stockmarket crash than the people with everything in medium risk investments.

Whatever happens you know half your money is safe. That is the big attraction.

Of course it is only an idea. I put it here as something to think about not as advice you should follow.


April 5, 2010. Money, Sensible.

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