The Greatest Trick

By Hayhoe Team
May 8, 2015

You may remember the old saying “The greatest trick the devil ever pulled was convincing the world he didn’t exist”?  Josh Brown, of the excellent financial blog “The Reformed Broker”, wrote a great piece earlier this year with this saying for a title, except he replaced “convincing the world he didn’t exist” with “convincing investors that volatility and risk are the same thing”.  It’s worth a read over at his blog “The Reformed Broker” and, for the record, I wholeheartedly agree with him.

Volatility and risk are so easy to equate.  The more volatile an investment is, the more risk we assume it has, and this is usually true.  However, where this doesn’t hold up is when looking at it the other way.  The less volatile it is does NOT mean it is less risky.  This is where the truth of the saying comes in.  Just because we don’t see something doesn’t mean it isn’t there.

We all love an investment that never goes down and just gradually grows each month.  There is nothing like opening your monthly statement and seeing your account has gone up yet again this month.  It reassures us we are on the right path and our investments have very little risk.

Be very careful with this.  Just because something isn’t volatile doesn’t mean there isn’t risk.  I am a big believer in properly structured, well-managed “alternative” investments. However, a number of “alternative” investments fix their Net Asset Values (NAVs) which leads to very smooth returns and the perception that there is no risk with these investments.  They never fluctuate like “traditional” investments that trade on an exchange where a free market of buyers and sellers determines the price.  This leads investors to believe there is little or no risk in these investments.  “Look, they just go up month after month”, they say.

When you hear that, think of the greatest trick.  Just because you can’t see something doesn’t mean it isn’t there.  Every investment has risks, and you need to understand what they are and when you could get hurt.

Bottom line, investment risk is the risk of permanent loss of capital, not short term trading noise.  You need to look below the surface and understand exactly what you own, how it is valued, what could go wrong, and how you can get out.  That takes time and effort that a lot of investors just don’t bother to put in when they are lulled into a false sense of security.  Don’t let the lack of volatility trick you into thinking there is no risk.  One day you could be in for quite a surprise when he shows back up!

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