In­vest­ment risk

Finweek English Edition - - INVESTMENT -

Once again I want to get on my favourite hob­by­horse t his week and dis­cuss man­ag­ing r i s k when in­vest­ing. This time it is spurred by the col­lapse of Mt Gox and Felx­coin, both Bit­coin ex­changes (well, Felx­coin called it­self a Bit­coin bank). Many people have lost cash or Bit­coins which they had at the ex­changes. This ar­ti­cle is not about cryp­tocur­ren­cies but rather about some very dis­turb­ing re­ports that I have been see­ing af­ter the col­lapse of these two Bit­coin ex­changes.

Ap­par­ently, a num­ber of people (I’m not sure that they can be clas­si­fied as Bit­coin in­vestors) had their en­tire life sav­ings in Bit­coin and with the col­lapse of ex­changes, they have lost ev­ery­thing. With re­spect to these people, this struck me as in­sane. Putting your life sav­ings into any sin­gle in­vest­ment is ab­so­lutely as high risk as it can be, re­gard­less what that in­vest­ment or prod­uct may be.

We get suck­ered into an in­vest­ment with the prom­ise of mas­sive wealth in a f lash and Bit­coin cer­tainly had that al­lure, but any in­vest­ment is about man­ag­ing risk vs re­ward and any­thing of­fer­ing huge re­turns equally of­fers huge risk. Un­for­tu­nately, as hu­mans we most of­ten get blinded by the re­ward side of the equa­tion and ig­nore the risk – how­ever, you can’t have one with­out the other.

But there is a big­ger is­sue at play here – how we broadly man­age risk. I have of­ten spo­ken about di­ver­si­fy­ing across sec­tors, stocks and even as­set classes to re­duce risk. No mat­ter what the in­vest­ment, even the most bluest of blue chips is high risk if your en­tire in­vest­ment is in a sin­gle stock.

We need to in­vest across dif­fer­ent sec­tors to re­duce the risk of a sec­tor fall­ing out of favour – wit­ness what we’ve seen in the con­struc­tion sec­tor since the days of the boom leading up the 2010 Fifa World Cup.

We also need to in­vest in dif­fer­ent as­set classes. An ob­vi­ous class is stocks, but we also need to have property and maybe even debt (such as Govern­ment bond ETFs or pref­er­ence shares) to fur­ther re­duce risk while also in­vest­ing in dif­fer­ent ge­ogra­phies. Again, we can use ETFs to get easy ex­po­sure to dif­fer­ent global mar­kets and as­set classes re­duc­ing the risk of a sin­gle coun­try or re­gion.

The di­rect is­sue with Bit­coin is the reg­u­la­tory en­vi­ron­ment. What sort of pro­tec­tion is of­fered if things get hacked, stolen or just close down? In the case of Bit­coin, noth­ing, hence the mas­sive risk of putting ev­ery­thing into a Bit­coin ex­change. Sure, this lack of over­sight is a large part of the at­trac­tion of Bit­coin but this means that when things go wrong one has no re­course to au­thor­i­ties.

A lo­cal bro­ker would be reg­is­tered with the JSE, who in turn has a guar­an­teed fund of­fer­ing pro­tec­tion to in­vestors in the event of theft or bankruptcy.

That said for­eign ex­change (FX) and con­tracts for dif­fer­ence (CFD) trad­ing plat­forms have no di­rect Fi­nan­cial Ser­vices Board over­sight, mean­ing that these carry coun­ter­party risk. Counter-party risk is the risk that you take when the counter party (FX or CFD is­suer) goes bust and you’re left car­ry­ing the can. JSE­traded prod­ucts have no counter-party risk and if you are trad­ing FX or CFDs, you need to make sure that the plat­form which you trade on is above board and that you have done a thor­ough due dili­gence on these plat­forms.

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