Inv- Risk 4- Ian McKeever & Co.

Risk & Reward.
Risk and reward go together, the expected return on investments is directly related to the expected risk, at least where there is an open market. This means that higher expected returns can be achieved the greater the expected risk you are prepared to take.

The key word is “expected”. It is used in the statistical sense of on average. It means that if you have infinite resources and invest in high risk investments for an infinite time, you will make a higher investment return.

It should be noted that in order to change the expression from “probably make a higher return”, into “certainly make a higher return”, two conditions need to be fulfilled

You need infinite resources as otherwise in the face of disaster you might run out of money.
You need infinite time because otherwise you might take the money out when the market is particularly low or after a long period of poor performance.

Private individuals have limited resources and limited time horizons and so they cannot achieve certainty. Within those constraints any investment strategy involves some risk of losing money. If you have a reasonably large amount of money and a reasonable period of time to invest you reduce that risk, but you do not eliminate it.

In practice according to Barclays Capital, in the last century equities have produced higher investment returns than any other class of asset over all possible 20 year periods. However the valuation basis of equities changed during the period. At the beginning of the period equities had a higher yield than Gilts, because of the risk that dividends would be cut. At the end of the period the dividend yield on equities was lower than on Gilts because dividends were expected to grow. Given that fact it is inevitable that it would be possible to chose a time period where that would be true. It happens to be 20 years.

The second comment worth making is that that enormous change in attitude will not be repeated, although it could be reversed.

There is a final comment to make about that little word “expected”. Although it is a statement about probability, the market does not explicitly work out what that probability is. It is simply implied in the price. Banks do try to estimate it in pricing their options and guarantee products. However in my experience the market frequently miss-prices risk and past events give little support for the idea that the banking system is any better.

Eliminating risk by investing in a guaranteed product.
Most such products give you a return of a percentage of the growth in the relevant equity index or just a high fixed return, on condition that the index does not fall by a specified amount. The exact terms vary considerably.

These may represent a a good investment but what you should note is that if you invested in the underlying equities you would have received dividends on top of the capital growth. It is the dividends you lose and that is what buys your guarantees. The comment was made above that equities outperformed all other assets classes over any 20 year period in the last century according Barclays Capital. It should be noted that that statement applies with dividends reinvested. You may therefore have reduced the risk but part of the price you pay is the loss of dividends.

Once one talks about equities, one talks about capital growth. However capital grow is far from the whole story. Dividends are an important part of the return you get from equity investment.

Investing in these products you eliminate much of the risk but at the cost of eliminating some of the investment return as well. You may get more than 100% of the capital growth but there is generally a ceiling on the maximum return. In addition if the market performs badly you may get no investment return at all over the period of the contract and that represents a real loss if prices are rising.

These products enable you to invest in equities and sleep at night without worrying too much. Whether they actually provide an enhanced return is a more open question.