Downside of being excessively cautious

When it comes to investing, playing it safe can mean only generating modest returns.

Investing money is very different to holding cash in a bank account. When we place our first investments, we need to teach ourselves to understand the concept that we could lose money. If we let our apprehension take precedence we can end up with a relatively cautious portfolio, even though the timescale of our investment could be decades (e.g. for a pension). This is likely to result in significantly lower returns.

First it’s important to understand that market fluctuations are an essential ingredient of investing. If you are investing for a long period (over 10 years) via regular savings then you should actually welcome market setbacks. They result in your new contributions being invested at a more favourable price.

The evidence historically has been that the highest returns are generated by ‘real’ assets

If you are investing a lump sum then you can replicate this effect to some extent by phasing your investment, possibly into four tranches over the course of 12-18 months. Again, this protects you from the understandably disappointing result of investing all your money just ahead of a big market fall and then rueing the day for years.

When it comes to the underlying content of your portfolio, the evidence historically has been that the highest returns are generated by ‘real’ assets, namely equities and properties, rather than fixed interest bonds (though the latter did perform extremely well for 30 years after 1982). Therefore, if the timescale is long it usually makes sense to have a high exposure to real assets.

When your attitude is risk is assessed look carefully at the results. If it suggests that a Cautious portfolio is recommended even when your timescale is measured in decades it will be worth double-checking some of the answers to your questions. However, if you are a beginner and likely to panic when markets drop then it may be better to tolerate lower long-term returns.

EQ tip: if you are investing for the long term try to come to terms with volatility – it’s an inevitable consequence of maximising returns.

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