WHY THERE IS NO SUCH THING AS A RISK-FREE INVESTMENT

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It is estimated that UK investors have 10 times as much money invested in bank deposits as in shares. This is despite interest rates having been at a record low level for 13 years up until February 2022 when rates started to rise. Why is this? It cannot be because these depositors were happy with the returns they were getting.

So why do investors invest disproportionately larger sums in bank accounts than in shares? The only explanation is that they think their money is safer in a bank deposit account than investing in shares. In terms of not losing their capital that is correct but after taking into account inflation they lost money in real terms. If instead, they had invested in the FTSE 100 Share Index they would have achieved a return of just over 90% over the same 13-year period.

Bank accounts are safer than shares in terms of protection of your capital. For example, they are covered by the Financial Services Compensation Scheme with protection of up to £85,000 per banking group. Individual shares do not have investor protection but OEICS and unit trusts do have the same level of protection.

Furthermore, long-term studies such as the Barclays Equity Gilt Study have shown for more than 100 years that shares outperform government stocks and cash over longer periods of at least 10 years on more than 90% of occasions.

However, banks do sometimes fail. The UK bank Barings went bust in 1995. Interestingly, depositors lost any amounts they had deposited above £20,000 which was the then investor compensation limit whereas investors in Barings Fund managers’ funds didn’t lose a penny because the company had an independent custodian to protect their funds.

Barings isn’t the only bank to have failed. Famously, the Lehman Brothers Bank in the US went bust in 2008 during the Great Financial Crisis. There were other banks that failed too.

Over the 60+ years’ history of the Investment Association, no OEIC or unit trust has failed and lost an investor money. The same cannot be said of banks.

Bank deposits or cash are considered low risk investments generally and by the regulator the FCA. However, they are not low risk when you take into account inflation which is currently at 10.1%. Even with a top deposit interest rate of, say, 3% you would still lose more than 7% a year in real terms (inflation adjusted).

UK government stocks or gilts are considered low risk investments generally too and also by the FCA. Government stocks are issued by the government and are guaranteed to be repaid on maturity.

I have long held the view that due to the unprecedented period of 13 years of record low interest rates in the UK between 2009-2022 of 0.5% or less that gilts had become a high risk investment because a rise in interest rates would inevitably result in a fall in the value of bonds including government stocks.

Since January this year, the value of gilts has fallen 52% whereas the value of index-linked government stocks has been even worse with a fall of 70% in value.

By contrast over the same period, Bitcoin has fallen in value by just under 52% meaning it slightly outperformed government stocks over the same period and outperformed index-linked government stocks considerably. Quite ironic when cryptocurrencies are considered high risk investments generally and by the FCA in particular.

What these examples prove is that no one asset class is totally risk-free and that it is far too simplistic to put a label on each investment classifying it as low, medium or high risk. This is because different asset classes change in riskiness at different stages of the economic cycle. For example, because share prices are relatively low currently, you could argue that they are lower risk than government bonds for long-term investors at the current stage of the economic cycle.

When referring to the riskiness of different assets we are not really talking about the ultimate risk which is absolute loss of capital. What we are mainly talking about is the volatility in prices of such assets. I much prefer Warren Buffett’s definition of risk “Risk comes from not knowing what you are doing.”

As long as you are prepared to invest long-term for periods of 10 years or more I would contend that you should primarily invest in shares with a lower percentage in property and ignore bonds completely unless, and until, inflation and interest rates start to show a consistent, downward trend. That would then be a good time to invest in bonds. You know it makes sense.*

*Risk warnings

The value of your investments can go down as well as up, so you could get back less than you invested. Past performance is not a reliable indicator of future performance.

The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.


Tony Byrne

Chartered and Certified Financial Planner

Managing Director of Wealth and Tax Management

If you are looking for expert guidance in Financial Planning contact Wealth and Tax Management on 01908 523740 or email wealth@wealthandtax.co.uk