An investment story
Once upon a time there were a bunch of people that worked hard and spent less than they made. They used the money they did not spend to invest so they could earn interest, dividends and possibly capital gains. They called this unspent money savings.
Some of the people did not want to make investments that they thought were risky so they invested in risk free and safe investments. Other people wanted to make more than they could on the safe investments and they invested in riskier investments. The people with the safe investments saw their money grow steady – slow but steady; and they felt secure. The people with the riskier investments also saw their money grow steady, however it was at a faster rate. They never felt entirely comfortable but were OK with it since it grew at a much greater rate than if they invested in a way that they would have felt completely secure.
One day a terrible thing happened and the people with the risky investments saw their assets steeply drop in value – as much as 50%. They felt miserable, uncomfortable, insecure, and angry. The people with the safe investments did not see anything drop at all, and they felt very happy, comfortable and secure.
Well, a funny thing happened afterwards. It seems the people with the safe choices started to get paid much less for their savings – in some cases there was a drop of 60% to 70% in the interest paid to them. Their principal remained the same – untouched – safe and secure – but the income dropped so much that they started to feel miserable. On the other hand, while the people with the risky investments saw their assets drop greatly, the dividend checks they were getting hardly dropped at all. Their cash flow remained the same – they still felt insecure, uncomfortable but only had minimal changes in their cash flow and they did not have to curtail too much of their spending.
And then one day their assets went back up to what it was before the drop, so they started to feel much better and began to forget that they once felt so miserable, and the dividends kept coming with continued increases. So, life went on as it was before the terrible drop. They still felt somewhat insecure, but weren’t feeling miserable, uncomfortable or angry.
The people with the safe savings were receiving so much less income that they started to feel miserable – and that made them feel less secure and uncomfortable and angry. And they started to figure out how they could cut back on their spending.
The people with the safe investments had insured bank certificates of deposits. The people with the risky investments had their money in a diversified stock portfolio. The drop described above occurred from the beginning of 2008 through the end March 2009.
The moral is that risk is subjective, needs definition, understanding and a focus on the goal of what is more important – secure asset values or a sustainable and reasonable cash flow.
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