Sunday, June 15, 2014

Bullshit financial theories part 5: Risk-free investment

I recently read an article by a Malaysian investor claiming that certain stocks had no risks. Let me just clarify, I don’t think that this guy is bullshit. In fact, I think he is a successful businessman and that he means well. But I strongly disagree with his opinion on certain plantation counters having no risk. To be fair to him, he later clarifies that by saying there may be short-term market risk, but in the long-term investors will certainly make exceptional profits. But how can he be so sure? After all, the profits of palm oil plantation companies are highly dependent on the price of crude palm oil. And there’s always the possibility that if CPO prices are high, supply will increase and drag CPO prices down to levels that allow plantation companies to only earn average returns on capital. When I say there’s no such thing as risk-free investing, I meant both in the short-term and the long-term. Anyway, the rest of this article will not be related to what this investor said, instead I will further elaborate why I think the idea of risk-free is a myth.   

Side note: I personally have no idea how the palm oil plantation sector will perform in the long-term (I hope it does well, as a stock I own has some exposure to this sector).  

If you studied finance in university, you would have been taught that government securities were risk-free assets. All you have to do is look back at the European sovereign debt crisis to know that this isn’t the case. In fact, by investing long-term in U.S. treasury bonds (which are thought of as one of the safest assets in the world) at current yields, you will almost guarantee that your investment will get fucked in real terms when all is said and done. The ten year treasury has a yield of 2.60% and the long-term inflation rate is around 3-4%. Good luck using the proceeds of the Treasury bond in the future to buy as many cheeseburgers or mamak dinners as you could buy today.  

Even companies with large economic moats bought at low prices are not a sure thing. Sure, it would take a real shit storm for a company like P&G or Nestle to get its intrinsic value impaired. But such shit storms are still within the realms of possibility. Before I invest in something, I have to be reasonably sure that it can deliver above average returns. But I understand the risks, and I monitor the performance of the company to see if any major risks materialize and act accordingly. Once you think your investments are risk-free, you start becoming sloppy and the probability of losses increase. Thank you for reading. Take care and stay rational.

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