Year of investing dangerously

The days of playing it safe are over. If you want a decent return on your investments in this age of economic volatility, perhaps an unorthodox strategy is needed: take a risk to lessen your overall risk.

The Swiss-based pharmaceutical group Novartis has a dividend yield of 4 per cent. Sebastien Bozon / AFP

Some investors live for danger. Getting rich slowly isn't for them. They don't want the hard slog of building a carefully balanced portfolio of shares, cash and bonds. They want racy growth stocks - and they want them now.

Other investors are safety seekers. The thought that a stock market dip could wipe out 10 per cent or 20 per cent of their wealth in a matter of days fills them with dread. Market volatility gives them the shivers and they struggle to cast off the comfort blanket of cash.

Most people are somewhere in the middle. In the days before the financial crisis, dealing with danger was a lot easier than it is today.

Safety seekers could comfort themselves with returns of 6 per cent or 7 per cent on cash. They could snuggle up to a balanced portfolio of bonds. Property looked a solid investment. They might have enjoyed a seductive flirtation with stocks and shares.

Adrenalin junkies were also spoiled for choice. China, India, Russia and Brazil were flying, property prices looked like they would rise forever and buying off-plan was a one-way bet. Double-digit returns were the order of the day.

Now we live in an upside-down world, where safe investments are no longer safe and dangerous investments are even more dangerous.

With danger everywhere, risk is almost impossible to avoid. So how do investors respond?

Your first step is to work out how you react to danger.

Avoid the temptation to play it too safe, says David Hughes, the senior area manager at PIC (Middle East), the wealth adviser. "You can lose just as much money by being too cautious as being too aggressive because you won't generate enough growth to beat inflation, which means the value of your holdings will fall in real terms."

Conventional investment wisdom suggests that the greater the risks, the greater the potential rewards, says David Kuo, the director at Motley Fool, the stocks and shares website. "Academics have tried to quantify the relationship between risk and reward using fancy mathematics, but I prefer something much simpler. It's called the sleep test. If you can go to sleep at night without worrying about your portfolio, your exposure to risk is about right."

Mr Kuo says the key is to have the right balance of investments that can produce income, growth and a little bit of excitement. "Almost every investor needs a little action. You want to sleep easily, but you don't want to fall asleep when looking at your portfolio."

Before the banking crisis, cash was considered as safe as, well, houses, says Mark Dampier, the head of research at Hargreaves Lansdown, Britain's largest financial advisory firm. "Now we know that isn't true. If governments hadn't bailed out the major banks at the height of the financial crisis, many savers would have lost everything."

Another supposedly safe haven, government bonds such as US Treasuries and UK gilts, could quickly turn into stormy waters. Many analysts fear we are in the middle of a bond bubble. If it bursts, things could get messy.

Bonds pay a fixed rate of interest, which makes them unappealing when inflation picks up. If all that central bank money printing finally kick starts inflation, investors could flee for the exits and bond prices could collapse.

Another worry is that bond yields have plummeted to their lowest level in 300 years. "Two decades ago, US Treasuries yielded up to 8 per cent and UK gilts yielded 11 per cent. Today, investors get less than 2 per cent. We have a mispriced market because it has been manipulated by politicians and central bankers through low interest rates and quantitative easing," Mr Dampier says.

It is almost impossible to judge risk anymore, he adds. "Twenty years ago, it was pretty straightforward. No longer. This is the most difficult time I have ever known for investors."

Many investors have turned gratefully towards dividend-paying global blue-chip firms. They offer yields of between 4 per cent and 6 per cent, with the prospect of capital growth in the longer term.

There are scores to choose from, including the Swiss-based pharmaceutical group Novartis, which yields 4 per cent, the American tobacco company Philip Morris International (4 per cent), the German insurer Allianz (4.6 per cent) and the British mobile phone giant Vodafone (6 per cent).

These are solid global companies, but they aren't entirely free of risk: your capital could still be punished by a market crash.

It is also worth keeping an eye on a stock's dividend payout ratio: that is, the dividend as a percentage of the company's profits.

Wherever you put your money these days, you are taking a risk, says Jeremy Batstone-Carr, the head of private client research at Charles Stanley Stockbrokers.

"The West faces serious underlying problems, such as high levels of debt and ageing populations, and neither politicians nor voters have shown the will to tackle them. Until they do, the dangers to investors will only grow."

Markets have only been spared a meltdown by European Central Bank president Mario Draghi's pledge to save the euro "whatever it takes", and the US Federal Reserve's launching of unlimited bond purchases through its third round of quantitative easing.

If playing safe is so dangerous, embracing danger may paradoxically be safer than you think. The more risks you take, the less overall risk you have, says Clem Chambers, the founder of Advfn.com. "If your portfolio contains just one defensive blue-chip stock, you are taking a massive risk because all your money is concentrated in a single company. It is actually less risky to pack your portfolio with 20 high-risk growth stocks. Two or three could go to the wall, but the rest should more than compensate."

Mr Chambers says in the longer run, a portfolio crammed with riskier stocks should outperform a portfolio of safe stocks. "The market actually pays you to take a risk. Very few financial advisers tell you this."

This isn't orthodox investment advice, but we don't live in orthodox times. "If you want any kind of return, you have to take a risk, while doing your best to diversify that risk away."

If Mr Chambers is right, living dangerously could be the safest thing investors can do right now.