Neil Lovatt: Spread risk as far and as wide as possible – and ignore the BBC

The claim was treated without any critical analysis, and the “expert” response described the experience as typical. It cited high charges, mis-selling, financial scandals and generally blamed the whole experience on the big bad financial services industry.

I’m certainly not going to defend the industry for some of its deplorable actions in the past. However I do believe that at times some people struggle to find a balance when it comes to personal finance. In this case the expert correspondent had failed to apply any critical analysis and that’s why I had to complain.

The experience of the reader may have been valid but it is so atypical that the improbability of the event needs to be put into context. Anyone with even a remote knowledge of financial services would know that such underperformance over the past 40 years of financial markets was highly unlikely, even for some of the worst investment managers.

So why did it even happen; why would the “expert” BBC correspondent respond so carelessly?

The recent market turmoil and the fact that markets still haven’t recovered from the 1999 highs clearly haven’t helped. With 13 years of disappointment why not just say they’ve been disappointing for 40 years; what difference can 27 years make?

But I suspect that the problem is borne of the complacency of the industry itself and its previous approach to encouraging investors into the stock market. Before 1999 the great and the good of the industry argued that provided you had a long-term horizon – say five to ten years – then investing in the stock market was safe.

The trouble is that is not true, and it never was true. The mis-statement was born of a fundamental misunderstanding and miscommunication of risk.

It is largely true that the longer you hold stock market investment the better your chances are of outperforming an investment in a bank or building society. But that doesn’t tell the whole story, which is best explained by a simple example.

Take a bet on a fair coin that wins you £1 when it lands heads but costs you 90p when it lands tails. If you are given one shot of the coin you might be suspicious and not bother, but say you were presented with the opportunity to take the bet as many times as you like; you would probably never stop playing. The longer you play, the better your chances and the lower your risk.

But say there was one twist in the bet – that if in the highly unlikely event the coin ever landed heads 50 times in a row you will be bankrupted and never allowed to play again. Now how would you feel about it? The more you play the better your chances of making good money, but the more you play the greater the chance of you being in the game when that unlikely but difficult event occurs.

It’s an extreme example but it hopefully illustrates the point: time does not take a toll on investment risk – it just changes the nature of it.

So with a better understanding of investment risk over time does that mean we are better off in cash over five, ten, 30 or 40 years? Unfortunately the answer is complicated and anyone giving you a glib rule of thumb for investing is just as guilty of a slapdash approach as the BBC expert correspondent.

The key to dealing with risk is to spread it as far and as wide as possible. That means looking at a range of different types of investments some risky, some not, and balancing them over time.

It often surprises people when I try to explain to them that investing regularly in, say, just the stock market can actually be a method of spreading your risk, at least in the early years. That’s because dripping your regular premiums into the market over time provides a level of stability which is balanced by the risk of the stock market. Whilst that’s true in the early years, conversely it is also why it is good practice to slowly switch stock market investments into cash as you near the end of your investment term.

Nothing is without risk and everything has the capacity to fail and disappoint from time to time. Generally it is better to spread your risks as much as possible but that sometimes means embracing a little risk.

As I’m discovering as I get older it’s better to mix a little bit of joy with a little bit of disappointment than lying awake at night hoping your one big bet will come off.

• Neil Lovatt is sales and marketing director at Scottish Friendly