Understanding ‘risk’ in investments: it’s not so scary after all
Although the two are often muddled, risk in investing is not the same as risk in gambling. So what’s the best way to think about it when it comes to our - and our children’s - investments?
By Holly Mackay
Risk is a funny word. It suggests forbidden fruit, danger, thrills and spills. It’s normally something that parents will refer to in their past lives, before the small tyrants redefined our daily routines.
I remember so clearly driving home from hospital with my son in the car seat, once we’d managed to wrestle that into place. We must have been driving at about 20 miles an hour and yet I was super anxious, getting used to the idea that he was no longer inside me, protected and safe. I had never felt less like taking a risk in my life.
No wonder then that, against this backdrop, more than 7 in 10 Junior ISAs we open up for our kids go straight into cash 1. We find it hard to reconcile taking risk with being responsible parents. But this cash-loving risk aversion is often a bad idea. We’re accepting the idea that our money will sit in cash for up to 18 years, making historically low-interest rates, as the cost of living creeps up and makes our money less powerful over time.
What is 'risk' really about in investing?
When we talk about risk, it’s interesting to learn how many of us think that investing is like gambling. ‘I could lose it all’. It becomes a two-headed monster in the dark – we don’t quite know what it looks like, but we don’t like it.
I usually turn the risk question around and pose it another way. Imagine a collection of some of the world’s biggest companies. What are the chances of them all going bust? At the same time? Little to none. If your money is spread out in investments in all these companies and more (which is easy to do if you invest in funds), how likely is it that you could lose it all?
There will be good days and bad days, as the value of each company rises and falls. There's always the chance that you could get back less than you put in, but if you're in no rush to sell your investments and can wait for the right time, you can minimise the risk.
Another way of thinking about the risk of investing is to look at how investments have performed throughout history compared to cash. In a study 2 that analysed stock market performance every year since 1899, it was discovered that over a two-year period, stocks and shares are 69% more likely to do better than cash. So-so, but extend this to a 10-year period and stocks and shares become a massive 90% more likely to do better than cash. As long as you’re thinking long term, you reduce the risk of being caught out in a downturn.
Parents can take advantage of these timeframes
Those with young children will have relatively long timeframes for some of their savings. Whether that’s for their own pensions or a savings account for young children with university fees in mind – all these things could be at least 10 years away. If so, it really is time to silence that internal parental voice which links risk to negative outcomes.
In our new podcast series, author Holly Mackay talks to Vernon Kay about some of the more modern risks of parenting – managing social media and screen time.