It is logical to seek safe and profitable investments for our savings. We do not want inflation to eat up the result of our work or of our efforts to reduce our standard of living, that is why we ask for profitability. But we also don’t want to assume the possibility of a loss.
Therefore, we look for a perfectly safe investment.
Total security does not exist
But the truth is that safe investment do not exist. There is always a risk. Sometimes it is so small that we consider it despicable but the truth is that it is always there.
The good times deceive us, they make us believe that nothing is going to happen, that everything will be safe, but it is not like that. Now, a few years after the turmoil of one of the greatest economic crises this country has ever known, we have become more aware.
I already explained that any option we choose has its risks.
- Neither government bonds present an absolute guarantee. Countries can suspend payments and make a write-off on part of the debt. We saw it recently with Greece.
- Also, the biggest banks can fail, as we saw with Lehman Brothers. Home prices can take a roller coaster ride, as we saw during the housing bubble.
- Even cash can be stolen or lose its value.
- A few years ago, there was talk of the possibility of an exit from the Euro, which for a country like Spain would have meant a devaluation of the currency.
Of course, he was talking about extreme cases. But it is important to know. The risk may be small, but it is there.
Investments cannot be profitable and safe at the same time
Profitability goes hand in hand with risk
If talking about safe investments is a slight exaggeration, talking about safe and profitable investments is an open deception.
One of the most basic principles of finance is that profitability is proportional to risk. Perhaps the clearest demonstration of this principle is the credits. A solvent person will be able to get a much lower interest rate than another less solvent person who asks for the same loan. To be compensated for risk, the investor needs profitability.
Today, any investment that promises a return well above the CPI has to lead us to prudence.
Unfortunately, there are many unsavory companies that market risky products, but they disguise them with nice verbiage. That is what happened with the Nueva Rumasa IOUs, to cite a rather famous example from recent years.
Profitability is the price paid to offset risk.
Why is return proportional to risk?
It’s very easy to understand. I could even say that it is common sense.
Let’s look at the case of a company that needs financing.
- Obviously, what you want is to get money in exchange for paying the lowest possible interest to the bank. You will talk to various entities, show them your financial data and forecasts, and choose whoever offers you the best price. On the other hand, the bank analyzes the risk that the credit represents, and proposes an interest rate that allows it to cover the risk of default and obtain a return.
- If all the banks consider that the company represents a high risk, all will impose a high-interest rate on it or will refuse to finance it outright.
Now let’s look at a different case, with investment in the stock market.
- Let us suppose the case of a company that suddenly has very good results and distributes many benefits to its shareholders.
- Those who had bet on the company for a long time, without being sure that it would be able to have those benefits, receive high profitability. Those who arrive later, buy the shares much more expensive and therefore get a much lower return.
- The former took risks, the latter is much less. Again we see how profitability and risk are proportional.
High returns have to lead us to caution
When a financial advisor offers us an investment that is too attractive, prudence should lead us to reflect. The entity is not our friend. It does not seek our personal benefit or our safety. Seeks your own benefit. So if they talk about profitable and safe investments, you should be suspicious.
The first thing is to ask for an explanation of such interesting profitability and its risks. If we do not fully understand how it works, it is best to give up. And if we understand, we will realize that the investment risk is much more significant than what they want to sell us at first.
Take the example of Nueva Rumasa .
- If I remember correctly, the company’s justification for issuing the promissory notes was the financing of a new factory, for a group in solid growth despite the crisis. They offered very high profitability.
- However, no matter how bad the banking situation was at that time, you can imagine that if a company of this size was really doing well and growing, it would have had no problems getting financing.
- Also, if you really chose to finance yourself with individuals, why did you use promissory notes and not bonds? Why a much higher return than normal?
- Nobody gives anything away. The high-interest rate was because the risk was very high and they had to attract investors. The notes were because they obligated them much less than the bonds, which are strictly regulated.
What are the safest investments?
Investing in fixed income is generally considered quite safe. In other words, the risk is relatively low, but as you already know, there is always a risk. Some examples of those investments considered safe:
- The deposits term
- State bonds (for those countries with a strong economy)
- Large corporate bonds
And of course, these investments offer a fairly low return lately.
Within the “safe” investments, we could also include the real estate sector, but with nuance. It is a safe investment if the investment opportunity is studied in-depth (that is, a flat or a house with good potential for resale or rental) and if it is bought in a healthy market.
What are the most profitable investments?
Investment products have very different returns over time. I can’t tell you which are the most profitable investments, but I can tell you the ones that are most likely to be profitable. Keep in mind that they could also end up being the opposite, with great losses.
Equities are generally considered to have better return potential than bonds. That is, we are talking about the stock market, and all its derivatives. We could also cite the commodity or currency markets.
Let’s be cautious when they talk about safe investments, and very suspicious if they add the qualifier of profitable to that. Nobody gives away anything for free in this life, and no matter how much they adorn it, it will not change reality: investing is a risk, and a high interest corresponds to high risk. Be very clear about it.