Security is a criterion of utmost importance for many investors who, out of pure risk aversion or prudential criteria with respect to their investment objective, try to eliminate or minimize the possibility of incurring losses.
Nuances of the psychology of the investment aside, the security of an investment becomes more important when closer temporarily speaking is the objective for which we invest. Time conditions the investment significantly because it grants or removes room for maneuver.
Imagine the case of two people saving for retirement. The first one is in the final straight, five years before retiring. For this person, security is a crucial variable, given the relevance of their savings objective and the importance of not squandering the savings effort of decades. Preserving the capital, in this case, is the priority. The second person is 30 years old and is beginning to save for retirement. Its time horizon of saving exceeds three decades and it needs to maximize profitability now that it has a lot of room for maneuver. In the case of this person, the risk is precisely not to take risks. Security loses relevance in this scenario.
Measure safety: volatility
Volatility is a measure of the risk frequently used in the field of investments. It measures how much the price of an asset deviates from its average value in a certain interval of time. The greater the volatility, the greater the risk, but also the potential gain, since the deviation can be both negative and positive.
Is there investment without risk?
A risk-free asset is one that offers a previously known return and its risk is zero, that is, its volatility is zero and therefore its value will not change over time. Given that profitability and risk are directly related, the risk-free asset will offer a low return and also the “risk-free” concept is subject to nuances. An example can be the public debt of a very solvent country: with very high probability it will face its commitments, but it can not be guaranteed with absolute certainty that the opposite will not happen.
Any investment that seeks additional profitability to that offered by this type of assets, must assume a greater risk. This is one of the basic principles of investment that everyone should be very clear about.
Which investments are safer?
Based on the security criteria, we could classify some of the best-known investments from lowest risk to highest risk, as indicated:
Savings and bank deposits
These products offer a fixed return known in advance and generally within a certain period. In environments with low interest rates, they usually offer a very low profitability, so these products are generally recommended for conservative investors who prioritize security to profitability. The inherent risk of these products would be the bankruptcy of the financial institution, although they are guaranteed up to € 100,000 per customer through the Deposit Guarantee Fund.
Fixed Income Investments
There is a wide variety of fixed income assets, some of the low risk (such as Treasury Bills) and others of high risk (such as fixed income securities of emerging countries). Profitability is fixed and known beforehand as long as the securities are held until maturity, although there are a number of risks:
- Market risk: the possibility that the securities are priced below the price we pay for them.
- Liquidity risk: this is the risk that there is no counterpart in the market and, therefore, that the product can not be sold.
- Credit risk: It is the risk that is assumed by the possible failure to pay the interest and/or the main investment by the issuer.
Investments in Variable Income
By variable income, we usually refer to the shares of companies, which we acquire in organized securities markets. They have listed securities and their volatility is higher than that of fixed income securities. In return, they aspire to obtain higher returns. Equity securities do not offer a predetermined return (although some offer periodic payments in the form of dividends) and their evolution is subject to internal variables such as the management of the company, but also to external variables such as political or macroeconomic factors.
Investments in derivative products
Derivative products are financial instruments whose value derives from the evolution of the prices of another asset, called “underlying asset”, which can be an action, a basket of shares, a fixed income value, a currency, raw materials, types of interest…
These are very high-risk products since they are subject to what is known as the leverage effect, which consists in that the investment actually made is lower than the actual exposure to the underlying asset, so there is a multiplier effect of both the gains as of the losses.