Investment risks and protections

Investing always involves risk. There is no such thing as an investment with no risk at all, and anyone who tells you otherwise is oversimplifying. Or outright misleading you.

Because if there is no risk, there is no potential return. It is that simple.

However, there are different levels of risk: from the very small risk of interest-bearing accounts or bonds to the extremely high risk of memecoins. And there are also certain protections, which depend on the investment vehicle you used, where you bought it, and the asset itself.

In this article I will try to summarize both points, so you can get a clearer idea of whether this investing thing is for you (spoiler: it is) and which option best fits your situation.

This article is the fifth in the series where I explain why you need to invest, how and where, so you can learn the essentials even if you are starting from zero:

1. Investing from scratch: where to invest your money.
2. Types of assets you can invest in according to their role in the portfolio.
3. How to buy assets: investment vehicles.
4. Investment platforms: where to buy investment vehicles or assets.
5. Investment risks and protections. (This is the one you’re reading).
6. My investment system.
7. Wealth: how to grow it, protect it and pass it on.

Risks of investing your money

I will tell you the main ones.

Market risk

The most obvious risk is market risk: prices go up and down. This is inevitable.

On top of what you already knew comes another one: believing we are capable of guessing when assets will rise or fall. And investing based on that.

This is what is known as trading and I will give you one fact:

90% of people who trade lose 90% of what they invested in less than 90 days.

Nothing further, Your Honour.

Or maybe there is, because English speakers have a very good phrase for it:

"Time in the market beats timing the market."

In other words, the return achieved by staying invested for longer always beats the return you get by trying to time the market.

That is why, when someone asks me: “and when do I take it out?” my answer is always the same: never, if you can avoid it. Let compound interest work its magic.

Little diversification

Another important risk is poor diversification. If you concentrate too much in a single asset or sector, you expose yourself more than necessary to its price swings.

That is why, once you have certain amounts in your portfolio, the normal thing is not to have everything in gold, Bitcoin or real estate, but to choose several assets and hold a portion in each one.

In this regard, I recommend that you look into the permanent portfolio or the four-seasons portfolio. 

It is a way of investing designed to work in any economic scenario, without needing to predict what will happen.

So, it uses one asset for each of the four possible economic scenarios:

• Economic growth: 25% stocks.
• Recession: 25% bonds.
• Inflation: 25% gold.
• Deflation: 25% cash.

This type of portfolio will never be the most profitable, but it will not do too badly in any of the four scenarios above.

Of course, variationshave appeared, adding real estate or Bitcoin, or changing percentages, but the underlying idea is always the same.

Risk from our own decisions

Obviously there is the risk of making bad decisions: buying at the wrong time because of FOMO, selling out of fear or getting carried away by trends.

This is, in practice, one of the most dangerousrisks. We are not as rational as we think and, when money is involved, emotions usually weigh more than we imagine.

The economist Daniel Kahneman, Nobel Prize winner, studied for decades how we make decisions and showed that we are full of biases. Some of the most relevant ones in investing are:

• Loss aversion: the pain of losing is greater than the satisfaction of winning, which leads us to sell at the wrong time.
• Overconfidence: we think we know more than we really do.
• Confirmation bias: we look for information that reinforces our ideas and avoid information that contradicts them.

That is why one of the best ways to protect yourself is to have a clear system and stick to it, both when everything is going well and, above all, when things get ugly.

Not for nothing, studies by major asset managers such as Fidelity Investments have shown a curious result: many of the portfolios with the best returns were those in which the investor had done practically nothing for years. In some cases because the investor had died and in others because they had forgotten the account and did not trade with it.

The conclusion is clear: when you invest, very often doing less is doing more.

Platform risk

This is one that always comes to mind when we start, but we usually do not analyse it properly.

It consists of thinking about what would happen if a broker or financial institution where we have invested, or want to invest, ran into trouble.

I can tell you it is a real risk (Lehman Brothers, for example), but it is usually lower than the previous ones and you are much more likely to lose money through bad decisions or trading than through the bankruptcy of a broker.

Because there are also certain protections if that happens.

Protections you can rely on when you invest

This is where one of the most misunderstood concepts in investing comes in: investor protections.

Some people think their money is protected, full stop. Others think they can lose everything if the bank goes belly up.

The truth is that neither group is right, because there are certain protections that depend on where the intermediary is regulated and which investor-protection scheme covers it.

So, in Spain, banks and brokers are covered up to €100,000 per holder (FOGAIN).

In other European countries, that figure is usually around €20,000.

In the United Kingdom it can reach £85,000 and in the United States up to $500,000 under certain systems.

But there is one key nuance: this protection only applies if the entity fails and money or assets are missing. It does not cover market losses.

In other words, if you buy shares and they fall by 30%, nobody compensates you for that drop. That is not how the guarantee works.

That is why it is important to understand two things before investing:

1. That there are certain protections for your money.
2. That these protections cover operational problems, not investment decisions.

And this is how it works in the world of traditional, centralized banking. Because if we talk about DeFi and cryptocurrencies, the situation is different. There is no public guarantee. 

If the exchange where you keep your funds (bad move on your part) has problems or you lose access to your funds, the responsibility is yours.

In other words, you’re left holding the bag.

DeFi offers you many possibilities that are impossible in traditional finance, but in return there is no customer service department if you mess it up.

As Uncle Ben said: with great power comes great responsibility.

In the crypto world, nothing is truer.

Conclusions

If you invest, you need to be clear about one thing from the start: the fact that your money is “protected” because there are certain guarantees does not mean you cannot lose it.

There are several risks at play:

There is market risk, where the price of the asset goes up and down.

The risk of market timing or trading, believing you can get the entry and exit points right.

The risk of little diversification, by concentrating too much in a single asset.

The risk of your own decisions, shaped by emotions and biases such as fear, FOMO or overconfidence.

In addition, there is platform risk, which means the bank, broker or exchange has problems or goes bankrupt. This is the only scenario where protections come into play, but only under certain conditions.

In Spain and most countries there are investor-protection schemes that cover you if the bank or broker fails and money is missing, but that protection does not cover market losses. If you buy something and it falls, nobody compensates you.

That said, each country has a different protection scheme: in Spain it is up to €100,000 per holder; in many European countries, only up to €20,000.

Another key point is where you are investing. Investing through a bank, a broker or an exchange is not the same. Regulation, how assets are held in custody and the type of entity determine the real level of security.

The idea I want you to take away is simple: before investing, you need to know exactly which risks you are taking and distinguish between the asset’s behaviour and possible problems with the intermediary, which are usually much smaller and less relevant for your capital than the rest.

Next steps

If you want to go a little further, I invite you to continue with the next article in the series:

1. Investing from scratch: where to invest your money.
2. Types of assets you can invest in according to their role in the portfolio.
3. How to buy assets: investment vehicles.
4. Investment platforms: where to buy investment vehicles or assets.
5. Investment risks and protections. (This is the one you’re reading).
6. My investment system.
7. Wealth: how to grow it, protect it and pass it on.