Finance explained to my mother-in-law. Chapter II – Risk and return

If there is an absolute principle in Finance it is that there is no return without risk.

“Playing the stock market” or “playing roulette”, in the eyes of my mother-in-law and her propensity for risk, are in equal measure the work of the devil.

Neither have I, the few times I’ve been to the Casino, ever bet a penny. In fact, I must say that the way I find it boring and meaningless, it always surprises me to see how much fun people get to have.

Before Cristiano Ronaldo landed at Juve, I had never even bought any shares.

But, be careful not to confuse “propensity to risk” with “ignorance” or “knowledge” of the matter.

You can be a Bocconi graduate, have a Master’s degree at HEC, and still not be attracted by the “stock market game”.

As well, you could be a statistical genius, write in all the mathematical magazines of this world, make the Rubik’s cube with blindfolded eyes and hands behind your back, and never have the same intention to “play roulette”.

Risk appetite is a category of the spirit, immutable, probably hereditary. In short, you are born into it and you don’t change.

We talk about zero risk in Finance in the case of government bonds.

Today, if you had to give money to a European country, with the certainty that it will come back in one, ten or fifty years, which one would you choose ?

Did you say Germany? That is correct. In fact, there is no return on German government bonds, which means they do not pay interest, because all investors are quite sure that the money they lend will not end up in the toilet flush.

The same, unfortunately, cannot be said for Italy. And that’s where the famous “spread” comes from. That is the additional return that every investor requires (currently 2-3%) to entrust their money to Di Maio, Salvini and all the rest, instead of Angela Merkel.

It is mostly money from the ECB and foreign institutional investors, destined to this ungrateful mission.

Because no Italian, knowing well who sits in the Parliament, would ever put their savings in their hands. Not even if they had a 1000% guaranteed return.

To the “country” risk is added that of “business”. And you get to “stocks“.

Also in this case, having to choose a quite safe sector in Italy, bankrupt proof, we would all probably say the banks. The banking securities, in fact, are generally those with a lower return, because they are less risky.

The banker who asks you for a complete check-up of the whole family until the seventh generation to lend you ten euros and in return calls you at three in the morning to remind you that you owe him a penny is in fact the embodiment of prudence.

The stocks that you can potentially make more money with are those that bear even more risk. Whether it is linked to the business, the credibility of the management, the capitalist structure or something else.

Then, of course, there are the exceptions such as the family pharmaceutical laboratory that nobody knows that suddenly discovers the treatment of the coronavirus, making a bang.

In the meantime, stock exchanges around the world have lost 60-70% of their value in a couple of months.

Those who are averse to risk, by nature more cautious, wonder if everything will ever go back to the way it was before, imagining catastrophic scenarios for the world of economics.

Restaurants will have to divide by 2 their seats, mass tourism is over, we will never go to the beach again, there will be lay-offs, unemployment, Mes, locusts, recession, we will go back to barter…

The value of stocks will be further reduced in a few months.

Maybe companies won’t even exist anymore.

Risk takers, on the other hand, are by definition dreamers. They imagine that in a reasonably short time, say by the end of the year, everything will go back to the way it was before and even those stocks will return to the antecoronavirus price.

For them then, investing in stocks today may seem like a good idea to earn money easily.

Even some friends of mine, little or much they have, lately ask my advice to become billionaires or not lose everything, in these times of uncertainty.

There are those who think of buying cryptocurrencies with leverage and those willing to buy a flat to rent just with their savings.

My answers disappoint them regularly and I can tell by the tone of their voice.

Unfortunately, the only thing I can answer is that buying leveraged cryptocurrencies (i.e. borrowing money from other interested investors) is extremely risky (but potentially very profitable) while buying a second home with your savings is extremely prudent (and certainly unprofitable).

For my part, I would do neither.

The fact that I “know” Finance does not mean that my propensity to risk, and therefore the return I expect from an investment, is a valid reference for everyone.

No one knows for sure what tomorrow will bring, but if there weren’t people ready to take risks, we’d be living in a sad world.

There would be no entrepreneurs and not even the Internet or smartphones.

For others, the future is a source of anxiety and they must always prepare for the worst.

The only mistake to avoid is to delude oneself that there are big profits in the absence of risk.

In conclusion:

  • Before making an investment, you need to have an idea of the risks involved, whether it is a two-room apartment to rent or derivatives to buy.
  • there are currently great opportunities in the stock markets (for those who believe that everything will return more or less as before) while safe and guaranteed returns have now been reduced to percentages close to 0 when not negative
  • (I’d forget about leveraged cryptocurrencies)
  • money doesn’t cost anything, so why not get into debt for an interesting project ?
  • the best would be to always diversify investments by mixing more risky and less risky ones

If, on the other hand, you have lost your job, you are worried about your future and have little desire to joke right now, forget about my bleating but don’t give up on your self-confidence.

You will see that tomorrow will be a better day and that in the end everything will be fine.