Do risk free investments really exist?

Over the past 19 years I have been asked such things as “What is the least riskiest thing I can invest in?” or “I want a great return but I don’t want to lose money!”  Never more so have people posed these types of questions than in the past 4 years. There are a lot of people who want to invest their money but do not want any risk or chance of losing money.

What is Risk?

Webster’s Dictionary defines Risk as a “chance of loss or injury; hazard; danger, peril. To expose to possible danger or loss; to take the chance of.” Oxford Dictionary defines Volatile as liable to change rapidly and unpredictably, especially for the worse.” I think the average investor doesn’t like the volatility that market investments bring. They want to protect what they have, get a nice return on their investments but want smooth sailing along the way.

Inflation is the big evil

Inflation has more of a negative effect on your portfolio than your return. A 1% less rate of return has a minimal impact on your portfolio then a 1% increase in inflation. Inflation will eat up your money fast. When we invest we need to stay ahead of inflation so that you have buying power when you need that money.

There is no such thing as a risk free investment

As far as I know, there are no risk free investments. Every investment that you place your money into has risk and reward to it. There will be negatives and positives for every investment.

Let’s use the 2012 Andex Chart to compare returns and inflation and to keep things simple. If we look at the past 10 years, ending June 30, 2012, inflation over that period of time ran at an average of 2.0% so our goal is to earn more than 2% on our investments. Let’s compare GICs, Bonds, Canadian Equity and US Equity.

5 Year GICs earned an average 2.7%. GICs are great because the capital is guaranteed and you the end result is predictable.  The typical drawbacks to GICs are the lack of inflation protecting and that the interest you earn (outside of TFSAs and RRSPs) are fully taxable. Inflation risk is a big concern here.

DEX Long Bond Index of the past 10 years earned 9%. Long bonds have had fantastic returns over the past decade. Bonds have rewarded investors with higher returns but bonds carry interest rate risk.  Bonds can experience negative returns if and when interest rates increase. You only need to go back to 1981 to find that this index generated a negative return of -15.9%. However, over the long haul you have earned a healthy return.

S&P TSX Composite Index returned 7.6% over the same period. We don’t need to look too far to understand the risk of equities. In fact, 2001, 2002, 2008, and 2011 quickly come to mind. It’s been said many times that the reward of equities is higher potential returns.  Unfortunately, equities are also risky because of the possibility of significant drops in the short term. This is called market risk. Despite the drops from the tech meltdown and financial crisis over the past decade, you have stayed ahead of inflation and taxes for a positive net return.

US Large Stock Total Return for the past 10 years was a dismal 1.2%. With all the bad news that has come out of the United States since 2008 you would have still ended on the positive over the past 10 years. Barely, but still on the plus side.

Diversification and risk

No matter where you put your money you will have risk. We battle inflation, interest, market and longevity risk (The risk of living too long).  You cannot avoid risk. If you have a well diversified portfolio with a certain percentage of each investment you minimize your overall volatility and smooth out your returns.

Do not get over weighted in any investment class. A diversified portfolio can withstand anything that the market throws at you.

Written by Scott Wallace

Scott Wallace has been in the Insurance and Investment industry for the past 19 years. His role is to take what is important to his clients and help them make those dreams a reality. Scott is a CFP, CLU and a Qualifying and Lifetime Member of the Million Dollar Round Table.

2 Responses to Do risk free investments really exist?

  1. Well said!!! I couldn’t agree more that inflation is a huge risk. In fact I say (no I preach) that inflation is a far greater risk to retirement success (aka not running out of money) than is the risk of losing money on one’s investments. Sadly the retirees who are likely at the greatest risk are those who panicked in 2008-09, sold out at huge losses and have stayed out of the market.

    My next biggest concern is for the younger workers whose view of investing is tarnished by 2008-09 and perhaps by the experiences of their parents. I read many of these folks are investing far too conservatively for their age, I hope this is not to their detriment 30-40 years down the road.

  2. WALDO says:

    I got out of the market when I retired in 2008. Interest rates on savimgs sucks and the market even worse. I went into low ratio private mortgages. Have 3 now (2 commercial and 1 residencial). Rates are 10,9 and 8.5 %. Never go over 60% of appraised value with postdated checks. All legals etc are paid by the borrower. Sure I have to pay tax on all interest but still a for sure return any day.

Leave a reply

Notify me of followup comments via e-mail. You can also subscribe without commenting.

Headline Name: Email: subscribed: 0 We respect your privacy Email Marketingby GetResponse