What if investing in the stockmarket were risk free?
Before our compliance team has a panic attack, I should clarify that it isn’t. Which is both true and we’re required to repeat it ad nauseam for legal reasons as well.
No investment is risk free.
However, consider if the following investment mantras put out by politicians, financial regulators, pension fund managers and stockbrokers conform to their own rule of declaring that investing is always risky…
“Stockmarkets go up in the long run”.
Sounds risk free to me…
“Don’t fight the Fed,” which means not betting against what central banks are buying. Right now, they’re buying just about everything. Does that make it risk free to invest in just about anything? Can stocks fall if a central bank is printing infinite amounts of money to make sure they go up?
If you think such intervention from central banks is new, short term, or even unprecedented, consider the Greenspan Put. It’s as old as former Fed chairman Alan Greenspan looks.
The basic idea of the Greenspan Put is that central banks will protect stockmarkets from plunging by lowering interest rates. In other words, it was the name given to the realisation that the Fed would save investors, not just the banking system.
The Greenspan Put became the Bernanke Put when Alan Greenspan became Ben Bernanke. When Ben took over the Fed, I mean. The same idea began to mean QE instead of just interest rate cuts, but with the same goal. Limit the downside to stockmarket crashes. And without those, investing is… I’m not allowed to say what.
What about banking legislation which treats sovereign bonds as “risk free” by law? I think I’m allowed to talk about that, because it is what the law says…
Is government debt risk free because the law says so? Of course not! But it is, legally speaking… The academics agree with this too – they call sovereign bond rates “the risk-free rate”. Which suggests it is… risk free…?
My personal favourite example of risk-free investing guarantees is the Plunge Protection Team. It’s officially known as the Working Group on Financial Markets.
I’ll quote from Investopedia, because you may not believe me…
- The Plunge Protection Team’s official mission is to advise the U.S. president during times of economic and stock market turbulence.
- Critics fear the Plunge Protection Team doesn’t just advise, but actively intervenes to prop up stock prices—colluding with banks to rig the market, in effect.
An advisory team that “actively intervenes to prop up stock prices—colluding with banks to rig the market, in effect”? And they call it the stockmarket? This sort of manipulation is straight out the USSR! Prices will not be allowed to fall until morale improves.
But the point is, once again, that the risks of investing are crushed by yet another force.
With all these institutions busily goosing the stockmarket, how could it possibly go down?
The fact that it has managed to crash is quite remarkable in and of itself, to be honest… If you believe government policies work, that is.
People never seem to stop believing that a government intervention will have the desired effect. It’s as if wanting something and asking a politician to appoint a civil servant to do it will make it happen…
The most important of all things that politicians could appoint civil servants to do is goose the stockmarket. You’re about to discover why shortly. Not here, in the news. When pension funds and companies with pensions to fund reveal the effect the Covid-19 crash has had on them.
But today’s topic is about the risk-free nature of investing in the stockmarket. You see, it isn’t risk free.
No matter how many rules, institutions, working groups, bailouts or asset purchase programmes the goosers come up with, they will always fail to goose the stockmarket in the end. Mr Market is just too vindictive.
The more they try to goose the markets, the more the markets underperform. Japanese stocks never recovered from their bubble. European stocks have been going nowhere for decades. In the US, it’s just the tech sector that’s truly booming, not the wider market.
But, just because the implicit promise of risk-free investing in the stockmarket, for whatever reason, doesn’t hold true, that doesn’t mean you shouldn’t invest. It just means you need to control the risks.
As a strategy, controlled risk investing outperforms pretending investing is risk free. By a long shot.
As if you need the proof, here it is.
If you ask me, the best investors in history weren’t necessarily good at investing. They were good at risk management though.
This old Wall Street adage explains it better: “There are old traders and there are bold traders, but there are very few old, bold traders.”
Now, if you don’t mind me saying so, retail investors are not much good at risk management. They might be great investors, but few people understand the surprisingly intense maths which goes into calculating the optimal position size and stop loss of an investment. Not to mention when to sell out.
The underlying concepts are fairly intuitive, incidentally. It’s just that the maths which makes up the actual decision-making process… sucks.
For example, more volatile stocks need to be given a wider berth before they hit your stop loss. And you should sell out after larger gains to make up for this. Not to mention making them a smaller chunk of your overall portfolio.
All that seems obvious once someone points it out. Simple too.
But where exactly do you place the stop loss? How much of the stock do you buy? When is a stock’s run over? And how do you measure a stock’s volatility in the first place?
Let me tell you, the equations to figure all this out look like Greek to me – literally. They use a bunch of Greek symbols.
Now I’m not suggesting you learn Greek, nor the maths behind the calculations that use the Greek symbols. Although, if you have time during this lockdown, I do recommend learning about some of the equations. They expose a particular way of thinking about finance which is healthy.
The ability to think about risk as uncertainty and volatility instead of just “risk of losing money” can change how you see the world. It can give you the patience you need to weather losing positions, giving them time to come good. And it can prevent you from getting emotionally attached to certain investments as they plunge too.
But, in the end, you likely want a simple solution to all this. A black box tool which spits out all the answers to the risk-management decisions of investing. How much to buy, with what stop loss and when to sell.
Sounds too good to be true, right?
But it isn’t.
This black box tool does the maths for you and spits out the answer. It’s better than the Bernanke Put, the Plunge Protection Team and surfing QE. Because it actually works… It’s risk management instead of pretending the stockmarket is risk free.
Even our compliance team is a fan. It uses a related system to monitor our stock recommendations!
You can join our compliance team here and find out how to manage the risks of your portfolio in a quick and easy way.
Editor, Southbank Investment Research