Is it risky to invest in the stock market?

Society paints the stock market as a high-stakes game of chance, but is this reputation deserved?

Is it risky to invest in the stock market?

Society paints the stock market as a high-stakes game of chance, but is this reputation deserved?

People think I am a huge risk taker. I remember talking about starting businesses at a Rebel Business School event and one of the participants said to me, “It’s alright for you, Alan. You’re a risk taker!” I was shocked as this is not how I see myself.

I see myself as quite risk averse. I don’t like taking big risks with my money, my business or my life. I like to play it safe in so many ways.

This got me thinking, “Am I a risk taker?” What does the rest of the world see as risky that I see as the safe bet?

Do you think it is risky to start a business? Do you think it is risky to invest in the stock market? Do you think the safe thing to do is to get a job and stay there for the rest of your life?

Definition of risk

Recently, Katie and I were running the Rebel Finance School and were talking about investing in low cost, broad based index funds (what is an index fund?). That is where we invest all of our money and we don’t see it as a risky investment.

As we talked about our strategy and how we invest, one lady asked us what we would do in her situation. Lots of people started commenting in the live chat that we should ask her about her risk tolerance before we got to the strategy we would take.

The investment strategy Katie and I follow is seen as one of the riskiest investments by financial institutions. We have 100% of our money invested in stocks and shares through index funds. SCARY!!!

We don’t have any bonds in our portfolio at all.

Vanguard has a range of funds that they call LifeStrategy funds. They have different mixes between bonds and stocks and shares. Here is how they show them on their website. On the left of the diagram is 80% bonds and 20% shares (the most risk averse) to the right-hand side at 100% stocks and shares (what they class as the riskiest).

I found this fascinating as I actually see things as the complete opposite from Vanguard. I think it’s riskier to have more bonds in your portfolio. Why do I think this? Well, the higher percentage of bonds you have, the more likely you are to run out of money in retirement according to the Trinity Study (this is where the 4% guideline came from).

The higher the percentage of stocks and shares you have, the more likely you are to have money left at the end of your retirement.

This is the exact opposite to the diagram I showed you above where they say more stocks and shares equals more risk.

This made me wonder “How are they measuring risk?

How do you define risk?

Each Vanguard index fund has a risk score out of 7. The fund Katie and I are invested in is a 5 out of 7. Pretty risky on the scale.

I don’t think it is risky at all though. So I started to wonder how they measure risk. Here is what I found in the help section:

“This is the fund’s synthetic risk and reward indicator (SRRI), an industry standard measure from 1 to 7”

Well I don’t know about you but that cleared it up for me! lol. What the heck are they on about? So I delved deeper to find out what the SRRI indicator actually is and this is what I found:

In the European Securities Regulator’s methodology document showing how to calculate the SRRI of a fund they say:

“The synthetic risk and reward indicator shall be based on the volatility of the fund”

So the European regulatory body is defining risk as volatility. This confused me a lot as volatility means the fund goes up and down a lot. It doesn’t mean your chance of losing money over the long term. Volatility and risk are two completely different things for me.

My definition of risk is:

“What’s my chance of losing money?”

I think it is risky if there is a high chance of me losing money and not very risky if there is a low chance of losing money.

The EU governing body seems to think differently. This makes it seriously confusing for investors and anyone trying to understand how to invest their savings!

Volatility versus risk

Our strategy is SUPER volatile but is it really risky?

The stock market is VERY volatile. This means it goes up and down a lot! When Covid hit, the stock market crashed because future earnings were in doubt, the economy was shutting down and things had gone cray-cray! Between 12th February 2020 and 23rd March 2020, the Dow Jones lost 37% of its value! That is HUGE.

Katie and I had £186,000 knocked off our net-worth! That is huge volatility.

This was only a loss on paper as we never sold. The market bounced back; it always does over the long term. So where is the risk if you are investing for the long term?

In the next year the stock market not only recovered but went on to set new highs that surpassed those of before.

The stock market is always going up and down. It will crash again and it will surge again. We know there is another crash coming; there is ALWAYS another crash coming. So the stock market is volatile but does that mean it is risky?

If you were to invest in a broad-based index fund that tracked the S&P 500 stock market in the USA, here are your chances of losing money over different time periods, based on historical data from 1937 to 2021:

Source

If you invest for just a year then you have more than a 1 in 5 chance that the stock market will be down at the end of the year. That is pretty risky for me. I have a low tolerance for losing money.

However, if you invest for the long term (20 years plus), there has NEVER been a time in history that the stock market has been lower at the end of that period. NEVER! So where is the risk if you are investing for the long term?

The stock market is going to go up and down, it is going to surge and crash (volatility) but in the long term it always goes up (low risk of losing money) if you are invested in a broad-based index fund.

Starting your own business without debt might be a rollercoaster of a journey (volatility) but if you started without debt and without borrowing money, where is the risk?

Cautious funds versus risky funds

On and off over the years that we’ve been running Rebel Finance School, Katie and I have considered getting sponsorship to make the course sustainable. We would use the money to pay for web hosting, video hosting, content creation, promotion and a team to actually manage the events.

We looked at some of the biggest players in the UK pension industry to see if they are suitable partners for what we teach at Rebel Finance School. When we researched them we were absolutely shocked at what they offer their customers and how they pitch it.

Wealthify is one such UK pension provider. They group their funds to make it easier for you to choose and the funds are labelled according to how risky they are:

  • Cautious
  • Tentative
  • Confident
  • Ambitious
  • Adventurous

I would love to know if you had to pick one based just on the name of the funds, which one would you go for? Vote now below and tell me which one you would go for!

Katie did vote years ago when we didn’t know what we were doing in investing. Her first ever stocks investment was into a cautious fund. Katie herself says she is risk averse and this fund seemed to match her level of adventurousness! What Katie didn’t realise was that because she said she was low risk, her financial advisor put her in two funds, both of which only had about 45% in stocks and shares. This was when Katie was in her late 20s and she had decades of time to invest!

The financial advisor took risk to mean volatility not risk of losing money. With some reason. The companies think that if you say you are risk adverse then you will panic if your investments go down and sell them at the wrong time. Instead of educating you on the difference between risk and volatility they slap you in a cautious fund and damage your long term financial future.

Cautious funds in general get the worse returns over time. This is because they invest in underperforming assets such as bonds, cash and “safe / less risky options”.

Advisors at investments firms around the world are conducting surveys asking if you are a risk taker or not. If they did a survey for me they would probably put me into the cautious fund too as I don’t see myself as a risk taker.

If they ever looked at what I was actually invested in they would see me as a huge risk taker.

I see things completely oppositely. For me the riskiest fund for you to be in for your financial future is the cautious fund. That fund doesn’t even perform as well as inflation most years and your money is losing value every single year! WTAF. The fund they say is cautious is the one that you lose money in consistently??

I think the riskiest thing you can do for you retirement is put your money in the cautious fund. I know you love data like we do so let’s get geeky baby.

We took Wealthify’s five funds and looked at their performance from February 2016 (when they started) until June 2024. We also compared them to the Vanguard FTSE Developed World ex. UK fund (a low-cost passive index fund). We looked at how much a £10k initial investment would have been worth at the end of the period.

Have a guess which fund returned the worst. Clue: starts with “C” and ends in “autious”.

Yep you guessed it! The cautious fund performed the worst out of the funds analysed. If you had invested £10,000 it would have grown to £10,920 over 8 years (it’s actually a bit longer than 8 years but I’m going to round to 8 for ease of writing!)

You might be thinking “WOO! I made £920! Not too shabby”.

However! Just to keep up with inflation (i.e. your £10,000 has the same purchasing power 8 years later) you would have to have £13,066 at the end. The cautious fund made LESS than inflation in the 8 years.

If you had invested in the cautious fund you would have lost money after allowing for inflation

I find this crazy. I am paying a team of fund managers to lose money for me over the long term. Talk about risk! If you invest in this kind of fund you have a damn good chance of losing money over the long term.

The other funds they had didn’t do much better! Time for a graph! Watch this mini animation to see the results…

The thing I would love you to notice is that all the returns of the different funds pretty much follow the same course over the years. You can see all the investments dipped in March 2020 (the Covid dip) and then bounced back.

The five actively managed funds consistently under-performed the Vanguard fund which is a low-cost passive index fund. You have paid Wealthify extra, they have worked harder and they have got you FAR worse results.

The other key thing to notice is the purple inflation line. You can see that it beats 2 of the 5 funds!

Your investments in the cautious and tentative funds would not have kept up with inflation

The top Wealthify performer was the adventurous fund (designed for the “risk takers” out there!). With this fund would have ended up with £18,110 after the 8 years which is only about 60% of what you would have with the Vanguard low-cost index fund at £29,759.

Let’s look at the difference between the various funds visually and let’s see what profit you would have made on your £10k after inflation for each of the funds. In other words, how much on top of your £10k initial investment you would get back after allowing for inflation.

The finance industry has risk back to front

I think the finance industry has got risk back to front. The most risky thing you can do is give your money to trusted competent fund managers who will take time getting to know you and then actively trade with the promise of getting you better returns. In reality you get worse returns and pay higher fees for the privilege.

The thing that the financial industry says is the most risky gets far better returns over time. If you invested £10,000 in the cautious fund over the last 8 years, you would have made a profit of £920 (after inflation this is a LOSS of £2,146); the same £10,000 invested in the Vanguard fund would have given you a profit of £19,759 (or £16,693 after inflation).

Either way you look at it (including or excluding inflation), that is over £18k better off.

​Sometimes the “safest” thing you can do is the riskiest. It is all down to how you look at things and measure risk.

I recently wrote an open letter to the CEO of Wealthify calling him out on his investment strategy. I have yet to get a response.

​Let’s look at risk in a couple of different contexts…

Is it risky to start a business?

It is if you are borrowing a lot of money!

For years people have come up to me after the Rebel Business School courses that I run and said things like, “It’s fine for you Alan, you’re comfortable with risk!” I always look amazed as they say this especially after sitting through a 2 week course on starting a business without debt!

Upon reflection it can be risky starting a business but that risk doesn’t have to be money. You are probably going to have to risk time, energy and rejection but you don’t have to risk money!

For years my business partner, Simon, and I have been teaching five ways to start a business with no money.

​There are so many creative ways to build a business without debt. So why is starting a business risky? I don’t think it is!

​You can run a mini-experiment and test out your ideas without going into debt to do it.

If you follow a more traditional approach to starting up I can see how that would be risky. You spend months writing a business plan and researching the market, you go and get investment or a loan to finance your business and go hundreds of thousands into debt, you create everything, make it perfect and then offer it to market. You hope that people will buy!

This way of doing this is HUGELY risky and I would NEVER want to do it this way. If you start this way you risk losing the money.

One thing I do know is that if you do start your own business you are in for a volatile ride. Some days you will be on top of the world making sales and laughing and the next something will have happened to take the rug out from under you.

You will be in for a rollercoaster journey but if you start without putting money in where is the risk of losing money? I can’t see one!

Is it risky to invest in the stock market?

The answer to this depends on how you are doing it!

If you are betting on different individual stocks, trying to time the market and dancing in and out then it is hugely risky. It is gambling.

If you are investing for 15+ years in a broad-based index fund (What is an index fund?) then there is historically a lot of volatility but very little risk of losing money. Does this mean there will be no risk going forward? No, but it does mean it is one of the safer bets you can make.

​Katie and I feel so confident in this particular decision we have invested 99% of our net-worth into index funds (the other 1% is in cash for us to spend on lego and pizza).

Is Alan a risk taker?

Most of the world thinks so. Except Alan! lol

People look at me and think:

  • Entrepreneur: risk taker
  • Invested almost entirely in stocks: risk taker
  • Speaker, blogger, podcaster putting himself out there: risk taker

And in a way I am a risk taker but I don’t risk my money. I will risk my energy, my time and my effort. I will put myself out there and build things and see if anyone wants them, but money? Money, my future, my investments? Those I will not risk.

I am not going to risk the investments and money Katie and I have spend years building up. Not after watching my dad secure £3.6m ($5m) debt against the family home in the ’90s and then lose all of it. Not after having to spend 10 years plus of my life fighting the banks and helping my mum try and keep a roof over our head. There is NO way I am ever doing something like that.

I don’t see risking my time as a risk that is going to be catastrophic. I don’t see the risk of rejection as something that is going to cause me to lose my home and force me to fight the bank for a decade. I don’t see risking my energy as a massive risk.

I don’t really see myself as a risk taker. I have taken a safe bet investing in index funds over the long term and I minimise any downside of entrepreneurship by starting my businesses without debt and for free.

Why am I telling you this? Because I feel as though people look at me and think I am a risk taker and therefore OF COURSE I am going to say that investing in the stock market isn’t risky. This just isn’t true. After the family experience I have been through I hate financial risk and avoid it at all costs.

Are you a risk taker?

The investment world LOVES to give us these little tests to check our risk tolerance. I think they are the biggest load of rubbish ever.

If you really understood the different ways to invest in the stock market you wouldn’t see all of them as risky. If you saw the alternative ways to build a business with no debt you wouldn’t see it as risky. If you really understood how often people get made redundant, restructured or forced to re-apply for their own jobs would you see getting a job as safe?

​For fun, I took one of the risk tolerance tests. I found the University of Missouri’s risk tolerance test and took it to see how they would rate me!

Apparently I have an average/moderate tolerance for risk. Who knew?

Does that make any difference to my investing strategy? No. No difference at all.

I don’t see investing in a broad-based index fund like the Vanguard FTSE Developed world fund as risky over the long term. If you go in knowing you are going to buy and hold and not dance in and out of the market, your chances of losing money over the long term are very low.

My biggest bet…

To me, buying a broad-based global index fund and holding it over the decades feels like one of the safest bets you can make! I wouldn’t have put my entire net-worth there if I didn’t truly believe that.

Please let me know what you think

As always Katie and I spend a huge amount of time writing these articles and we do it for you! We want to know what you think. Please take a second to leave us a comment, question or thought. It means the world to us.

Disclaimer

This is not financial advice. Katie and I are not trained financial advisors, nor to we pretend to be one online. Read our full disclaimer here.

One Comment

  1. Marta Nastaj July 17, 2024 at 2:13 pm - Reply

    I am blown away how good this and all other of your articles are. My new insight, on top of solidifying my beliefs, is that you do not invest in any bonds but I guess it is because you are already financial independent and you have enough cushion to wait out and do not withdraw from your investments during the downturns.

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