That was then and this is now

I thought I would share this with you for no other reason than to make you smile. I know a lot of you remember me from back in 1994; it was a kind client called Ruth who reclaimed this from the bin and sent it to me.

This dates back to Spring 1994, however just look at the subject matter.

  • State Pension age for ladies rising up to 65 – there is currently a consultation to lift it to 67
  • Look at your tax year end pension planning before it is too late – still applicable today

Frequently asked questions.

Q: Is that a soft Deirdre Barlow type perm?
A: No. My hair is still curly thankfully.

Q: Is that thing on your top lip a smudge on the photo?
A: No. I liked to call it a moustache. It had taken 33 years to grow by then so I wasn’t going to shave it off.

Investment Risk

The chances and the consequences

It’s important we understand the risks we take in life. We need to understand the chances of something bad happening, but we also need to understand the consequences of something bad happening.

Many investment providers stress the large potential returns but almost fail to mention the associated investment risk. It’s an old sales technique. Maximise the benefits but minimise the costs. Their salesmen act like wizards who try to avoid mentioning you know who, “he who must not be named”. We take the opposite view. We believe that only by talking openly about Lord Voldemort can he, like investment risk, be understood and our inner fears controlled.

The chances of meeting Lord Voldemort are extremely low, but the consequences would be almost certain death. You have the same chance of meeting Ron Weasley, but the consequence would probably mean we would still see you again later.

I saw Lord Voldemort once at JFK airport. Actually it was the actor Ralph Fiennes that was in the immigration queue next to me and he was full of a cold. I still didn’t try to engage him in conversation though, thought it might be too risky. True story.

Is it Risk or merely Uncertainty of Outcome?

Investment risk sounds frightening and altogether final. Risk implies that if you don’t win then you must lose. Lose Totally. Completely wiped-out. But we know that most risks we take in life are not all or nothing. They really only involve a bunch of uncertain outcomes. You will achieve something, it will be just one of a range of possibilities. Here’s an example.

The light switch

When I was young the living room had the “big light” in the centre of the ceiling. A nod here must go to Peter Kay’s observations. The choice was simple, it was switched on or off. Living rooms today have down lighters, up lighters, floor lamps, wall lamps, table lamps…… Instead of one “big light” your lighting today can be adjusted depending on your requirement and mood. Forget the all on or all off choice of the 60’s. We can have a range of lighting outcomes. A range of outcomes made wider still by utilising dimmer switches.

When we invest the result is better seen as the variable output of a dimmer switch rather than the binary output of the old on or off switch. The dimmer is controlled by the markets. We don’t know what level of lighting the markets will deliver, but it is very unlikely to be either all on or all off.

We are not gambling here

Investment Risk can be seen as nothing more than a wide variety of outcomes over time. Only some of those outcomes involve actual loss. Only one of them involves total loss. Total loss occurs when everything you own is gambled. We choose heads, but the coin lands on tails. Investment is all about diversification across many things, absolute loss would involve every market, everywhere, being reduced to zero.

We know this. We know it can’t happen. Yet that uneasy gut feeling we suffer is because we still fear losing anything, as if we have lost everything. This is simply not rational.

The possibility of meeting a character from The Harry Potter Films is extremely low. But if you do meet one and it’s the wrong character, the consequences could mean a very painful death indeed. You could lose everything. Then again meet him on his day off, where airport security have screened every passenger for wands, and death would be only one of a wide range of uncertain outcomes.

Howard Scott, the grown-up who lived.

Low Volatility isn’t the same as Low Risk

Any client who has invested with us should remember answering question 6 of our risk profiler. When shown the chart below, clients are asked;

image

The chart above shows the return on £10,000 invested in three different investments (Funds A, B & C) over the last 10 years. Given the potential gain or loss over the whole 10 year period, where would you invest your money?

It’s a loaded question.

A few clients want the biggest return and guess that over the long term “Bold as Brass Blue” should prevail. They are the risk takers of the world and can withstand short term shocks.

Most clients simply look to the end of the period and select “Steady-Eddy Red”. The path has been steady with no nasty surprises. Just what we want for our life savings.

It’s a good question. It’s just a deceptive chart. The world carried on after 2005. Which leads me to my favourite Turkey story.

Everyday Bernard came across and fed the birds. They loved him. They let him stroke them. They followed him around the yard. Bernard was the most generous, friendly human in the word. “Humans are our friends” they would say. Why wouldn’t they, they got fed everyday, just like the last day. I guess you can see where I’m going with this story can’t you? Yep. Then they were stuffed and served with cranberry sauce. Yum yum.

If the turkeys were investors, they would be blinded by “Recency Bias”. The human affliction that takes learning from recent past experience a bit too far. Blindly expecting what has happened in the past to continue, without question, is not very wise.

The little risk assessment chart above was not based on fictitious data, it was based on real numbers. The Blue Line was the FTSE100 index and the Red Line was the UK Commercial Property Index (IPD). Now let’s look at just what really happened after the chart above ended in 2005.

Recency Bias

Whoops! A very swift 37% fall. Investors cried foul. (pun intended) Commercial property funds were forced to bring in their drawbridges and shut the door to withdrawals. In some cases it took investors 6 months to get their money out back in 2007.

QUESTION: How could such a low risk investment suddenly lose so much?
ANSWER: Low volatility isn’t the same as low risk.

cooked-turkey-hi

So what was the Goldilocks Green Line on the risk assessment chart? I will tell you next time.