no risk investingHave you heard of an investment with out risk? I have. At least once a month I get a offer in the mail, email in my in-box or see an ad in the newspaper for a new investment that promises an amazing return with no risk. 

Nothing scares an investor more than risk, and nothing contributes more to risk in investing than volatility.

Just ask investors in 2008 going from the highs in spring to a drop of more than 40%. Since then investors are looking a solution for their investment nightmares. 

Almost every new investment being sold today comes with the selling feature “it does not have the volatility of the stock market”. Many come with guarantees, others invest in alternative assets and some invest using a special investment strategies.

Let me first say I am biased. I am a big fan of simple pooled investing. Yes some of the fees are higher. yes some of these do not own the latest assets and if managed correctly the strategies are simple. But why am I not a fan of many of these new products …

1. Guaranteed Products

They bring peace mind to investors. Now there is no need to worry about volatility because your investment has a principle guarantee, but this guarantee comes with a price. All investing comes with costs but guaranteed investing have more.

Most investors have no idea the cost of the guarantee and how they actually work. Even with the massive drop in the stock market in 2008 few individual investors actually qualified for these guarantees. Yet all investors paid the fees. 

On top of this many companies that offer these guarantees have re evaluate the costs of these products and are now increasing these fees. 

Who pays for these guarantees … investors. Who benefits from them … the companies that sell them.

2. Alternative Investing

Why not minimize your risk by participating in ventures in variety of different asset classes to bring some stability to your portfolio. These investments seem less risky because they don’t fluctuate like the stock market. 

This is true … but you might want to ask yourself why? Most of these investments are ownership in new companies, special debt instruments, or long term real estate trusts. These types of investment are sold on the basis they appreciate in value,  so you would think these investment must go down too. But just how volatile are these investments? According to the promoters the are not risky as the stock market. How can they say this?

The answer is .. these  investment aren’t sold on “a market ” so there is no way to know how volatile these investments really are.  Is the investments value up, down, in favor, out of favor. The only time you know is when you are being sold to purchase or trying to sell to someone else.

A good example of this is small mortgage investment corporations. These investments are sold on basis of a good monthly return from rental property backed by rental real estate.  But what is in the real estate portfolio that produces this income worth? 

Try to sell the real estate when the economy is down, your renter won’t pay, the property value is down, and banks aren’t lending money.

Don’t get me wrong alternative investing is not all bad … but buying these investments because they don’t have “market risk” or volatility doesn’t really make sense. The reality is the only reason the value does not fluctuate is there is no open market to sell these securities so you only know the price when you buy and sell.

3.Special Investment Strategies

This is a favorite of mine. The magical method or technique that can produce a return with minimum downside risk.

This can be done with a special stock picking strategy like speed trading, or an investment product that buys the equities at a distance like derivatives.

The reason this whole argument that these methods avoid market volatility is silly is ultimately these investments still own stocks, or bonds. The idea you an own a investment that is traded on a market with volatility but you have none is ridiculous.

In fact by adding another layer to ownership, time to buy strategy, time to sell strategy, selling large blocks of stock in milliseconds adds another eliminate of risk that again most investors do not fully understand.

Many of these investments keep a huge portion of the return as payment. The push is for a quick return. These specialized types of strategies can also lead to a significant losses all in the search of the bigger win.

So what can you do?

Market risk and volatility is a real issue and needs to dealt with up front by investors. It’s impact on risk cannot be avoided. The key is not to avoid it but learn how it works and make sure to own an investment that has the amount of risk you can live with regardless of market volatility.

Repackaging investing with guarantees, the latest assets or fancy strategies does not necessarily avoid volatility and risk, it just masks it.  

The bottom line as an investor, no matter what you buy … if it goes broke so will you. And remember the difference between a good investment and bad one is not the return for today it is it the kind of investment you would hold when the market is down 40%.

“Risk comes from not knowing what you are doing.”

–Warren Buffet–

Check out this bulls and bears brochure from Mackenzie Financial. It makes for interesting reading