The Dirty Little Secret Of The Investment Industry

This could help non-experts make a lot more money

The investment industry has its own special language.

This locks ordinary people out of the game. And it costs you money. Understanding one simple idea will give you more in your investments (pensions, stocks, shares).

I want to share what I’ve learned so you can make more money.

But first, you need to know how I discovered this secret.

How I made this discovery

My parents inherited some money and wanted to invest it. We’d never had surplus money before. So they got a financial advisor who did a risk profile on them. Asking them a series of questions to assess their ‘appetite for risk’.

This revealed my parents wanted low-risk investments. So their advisor set this up for them.

This sounds good? But I soon found out it wasn’t.

Their investment went down more than it went up. This didn’t seem like a good deal to a novice like me. I decided to investigate. In doing so I stumbled upon the dirty little secret of the investment experts.

I realised there were 2 reasons my parents were losing money.

1. Unnecessary high fees. I’ve written about this before.
2. The other issue was confusion over risk. Which will be the focus of this article.

The problem with risk

Professional advisors and ordinary people mean different things when talking about risk.

This creates a nonsense situation. Ordinary people ask for low risk and end up making little money. Whereas high risk isn’t risky at all.

Confused? Let me explain.

When ordinary people say they want to avoid a risky investment. They mean 2 things:

1. They don’t want to lose the money they invested
2. They want to avoid not making money.

By this definition a high-risk investment is one where:

1. there is a high chance you will lose your money
2. there is a high chance you will not make any extra money

If you are a non-expert when it comes to investment. This will all sound obvious and straightforward.

So here’s the big shock:

This isn’t what a financial advisor means when they ask you about risk

For a finance professional risk means volatility.

Volatility is how much the value will vary over time. If an investment is likely to have some dips in value. It has high volatility. (Even if it is likely to end up much higher).

This bears repeating. If your investment is likely to go up but it varies on the way up. This is high volatility. ie high risk for professionals.

If you are investing for the long term. Volatility is irrelevant. It doesn’t matter if you have a few dips and a few peaks. What matters is will the value goes it.

The problem is volatility tends to have higher returns in the stock market. So when my parents were given a ‘low risk’ investment ie low volatility. They were basically guaranteed low returns.

This discovery did not make me happy!!!

They asked for low risk — meaning they didn’t want to lose their money. And wanted to make some.

What they got was a low-volatility investment — ie. lower returns.

But is it possible to get a high return without risking all your money?

Surprisingly. The answer is yes. And it is simple to do.

Here’s what I wished my parents did instead.

How to invest with the smallest risk

(quick note for the rest of this article I will use the ordinary meaning of risk ie. the chance of your losing your money and not making money).

The simplest way to make money over time is to invest in companies. You buy shares and then do nothing. Let’s look at how to do this whilst fulfilling our 2 risk criteria.

You really can have your cake and eat it.

Low risk 1 — how to avoid losing your money

If you bought shares in a few companies. Can you guarantee they will still exist in 5, 10, or 20 years? No. This is a high-risk investment. So best avoided.

Instead invest in an index fund. An index fund buys a small piece of lots of companies in a country, region or even the whole world. The fund aims to copy the whole market. You only lose all your money if the whole market goes bust. Which is pretty unlikely.

Low chance of losing your money? Box 1 ticked.

Low risk 2 — how to have a high chance of making money

You would expect an investment with a low chance of losing your money, would give you that security at the cost of making money.

Makes sense. But you’d be wrong.

Over the long term the stock market typically makes 8–11 %/year.

• S&P500 (US) made 10.13% since 1957
• FTSE 100 (UK) made 8.33% 1984–2019

Index funds over the long term have a high chance of making you money.

I found this unbelievable when I first realised this.

Add in the low costs of these funds. And they are even more attractive!

I use Vanguard funds. But there are lots of options available.

It is worth noting most people put their money in a savings account. Which I consider a high-risk investment.

Why savings are high risk (over the long term)

Inflation averages around 4%. This means savings need to make 4% not to lose value.

To make any money the savings interest rate needs to be above 4% over the long term.

The savings rate in the US/UK has been lower than inflation over the last few decades. This means the chance of making money is very low.

So if risk means the likelihood of making money. Savings are high risk because they don’t make any money (after inflation).

Final comments and warnings (please read)

1. Index funds are long-term investments. Only consider them for 5+ years of investment. The longer the better.
2. Ignore volatility. Put money in and leave it. If you will get stressed or anxious when your investment dips. Then do not use any stock market-related investment.
3. Finally I am not a financial advisor and no part of this article is financial advice.

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