To Risk or Not Risk, That is the Question

March has been and gone and I’ve not found time, or truth be told the inspiration to pen a single investment blog. At a time when I have been very busy with investment reviews and end of tax year planning, stock markets have fortunately been tranquil.

With equity markets hitting new highs my investment reviews have all followed the same theme, profit-taking and risk reduction. Profits from pure equity funds have been selectively switched to cautious risk and multi-asset funds in anticipation of a stock market sell-off this year. I hasten to add this is my view. I have no crystal ball; it is just a feeling or intuition. The trigger for a crash may be a political event, a financial or banking crisis or merely the “wall of worry” syndrome with nervous investors fearing ever rising share prices and heading for the door in a collective stampede.

Given this view it is simply not good enough to sit back and admire portfolio performance. This is because profits accruing in a portfolio are paper profits until they are crystallised and experience tells me they can disappear as fast as you can say, “The London Stock Exchange.” Tranquil markets have provided a rare window of opportunity to protect profits and therefore in my view is one not to be missed.

In summary in the short term I am cautious about equities, but in the medium to long term I am bullish, especially with the global economic recovery gathering pace. This creates a conundrum for me and highlights the risk of risk reduction. Firstly a crash may be sharp and rapid followed by a quick V shaped recovery. The fall-out from the June EU referendum was an example. In cases like this risk reduction is arguably an unnecessary and potentially expensive exercise especially if investors end up buying back into stocks at higher prices than they sold out of. In other words it would have been better doing nothing, staying invested and saving money on the advice costs as well. However few economists and fund managers correctly anticipate the timing of crashes let alone the trajectory of the subsequent recovery. A quick V shaped bounce is observable with hindsight but is not usually predictable in advance.

Even if the recovery is slow it is reasonable to argue that if I firmly believe the long term direction of equities is up why bother with risk reduction at all? Surely a buy and hold investment strategy should be adopted. Advocates cite the mantra, “it is time in the market not timing the market that counts,” and I have seen examples of this with mature portfolios. About two years ago I noted a £3,000 investment a client made in a European equity fund in November 1996 was valued at more than £21,500 less than 20 years later. The investment had been held through thick and thin – the technology bubble bursting in the early noughties, the financial crash in 2008, several Euro crises and various recessions.

The problem with a buy and hold strategy is that not everyone is a long term investor and many of my clients rely on investment income in retirement. Similarly with a number of my clients approaching retirement risk reduction has been essential. In contrast younger investors with secure employment tend to invest for long term capital growth and sharp dips in portfolio values and general volatility are less damaging.

Moreover a cautious approach that takes risk off the table is commonly adopted by fund managers. It is based on the idea that protecting capital on the downside is as important as capturing the gains when markets are rising. In other words risk reduction is a key element of long term investment performance. Defensive strategies are also likely to help fund managers, investors and their IFAs avoid the temptation to take too much risk to recover losses after a crash.

In conclusion risk reduction has its risks and costs especially if markets do not crash. However invariably the decision to risk or not risk will be determined by individual circumstances, timescales and attitude to risk. Long term or adventurous risk investors may say “do I look bothered?” when markets crash whilst cautious risk clients may not sleep well at the first sign of trouble. The importance of peace of mind is on a par with profits.

This blog post is my own investment thinking and commentary only. Nothing in this article should be construed as investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.