Nobody needs to explain that investing is risky. And everyone knows it can offer real financial returns. Indeed, that’s an important reason why investors start on the stock exchange, sometimes with borrowed money. So where is the risk? And what can we learn from the past? Five questions for APG’s senior strategist Charles Kalshoven.
“Let’s be clear: I think it’s good to see young people getting involved in their financial future from an early age,” stated Kalshoven before the first question has even been asked. “And they’re right that it’s just not been worth saving for quite some time, so it’s attractive to look for alternatives. Moreover, you can also learn a lot by getting involved in financial markets. However, there are obviously some pitfalls.”
But surely everyone knows the risks by now? Such as “past results offer no guarantee for the future” or “you can lose your investment.”
“Yes, but it can be difficult to imagine those risks. Certainly if you grew up in the period when interest rates just kept getting lower, savings offered no returns, and things were going well on the stock exchanges. Of course, coronavirus caused a crash, but for many people that was actually the right time to start investing. They bought during the dip and their investments are now often worth much more.”
What’s wrong with that?
“In principle nothing, but it can, however, give a wrong impression of what the market does. A young generation of investors has never experienced anything other than stock exchanges performing well. But if the past has taught us anything, it’s that a hefty correction or even a crisis will take place from time to time. If you’ve never felt the “pain” of such a situation, you may be inclined to take more high-risk investment decisions. Or you’ve been lucky in making good returns without realizing that the risks were much higher than you thought. You could have been cycling along merrily without noticing that you’d been cycling on the edge of a ravine.”
But it’s a fact that stock exchanges are still doing well. So you could say there’s no cause for alarm?
“Nobody can see into the future. What you can see, however, is that the Great Moderation is over – that’s the period in which high inflation was subdued and interest rates kept falling. Stock exchanges made major profits from those falling interest rates and company valuations increased considerably. And high valuations depress expected returns, so you shouldn’t just keep doing what you did in the past. Of course, you can still do really well on the stock exchanges even with those developments. I only want to say that new investors would be wise take into account scenarios that are less rosy than the current stock exchange climate.”
So what is your advice?
“Spread and re-balance. If you’re going for the long term, like pension investors, then it’s good to have a broad portfolio with a certain percentage in equities, a certain percentage of bonds, etc., which you come back to periodically. That’s the re-balancing. In fact, you then automatically exchange the categories that are doing well for categories that are lagging behind. It’s a proven method of improving your risk-return ratio. And you prevent that you trade based on emotion. But what’s even wiser is to invest in yourself instead of in equities. A study program often provides good long-term financial returns. And you also get a sense of satisfaction from this.”
But what if that study program is really expensive?
“Of course, with an expensive study program, you could invest to finance your study. Some people do this with borrowed money. But obviously, the risks are higher with borrowed money. After all if you lose a part of that money, you’re quickly straddled with debt. We call that the leverage mechanism, which we saw in the equity lease affair in the 1990s. At that time loans were offered for investment purposes, often to inexperienced investors, and loan providers weren’t upfront enough about the risks. When the share prices took a nose-dive in 2001, many people were left with a huge residual debt. In this respect, it’s simply safer to invest using your own money that you can afford to lose.”
Also read Daniël’s story who invested his student loan to pay for his pilot training.