Most people consider cash, fixed interest investments and equities (stocks and shares), as three distinct types of investment. In fact, the return on cash, the return on fixed interest investments and the returns on equities are all returns on capital invested in the economy. They are therefore all equity returns. An investor places money in a bank and receives interest on the deposit. The bank lends the money to a company that produces goods or services and receives interest for the loan. The return the company must earn on its investment must be higher than the money it pays the bank. All returns are generated by the company which pays the bank which allows the bank to pay the depositor. If economic growth were to collapse, so would the return on cash and fixed interest securities. Ultimately, cash and fixed interest investments would all cease to have value. The only reason cash is a lower risk investment is because a bank is able to spread the risk of all its loans and the financial system would come to its rescue in the event of default. But a widespread collapse of the economy would also see a widespread collapse of the financial system. After all, the money you place in a bank is not actually in a bank, but owed by an individual or a company. In reality, over the long term, investors in cash are taking the same economic risks as an investor in an equity investment while accepting a lower level of return. Because cash and fixed interest investments are exposed to inflation risk, cash and fixed interest investments are actually higher risk investments than equities over the very long term. If the above is true, why do people simply not invest in equities and avoid cash and fixed interest investments? Over the short term (the short term can be as long as 5 and 10 years and, in some case significantly longer) equities can be higher risk investments than cash and fixed interest securities for two reasons. Short term economic risk - the value of a company depends on its current and expected future earnings. During a recession, both current earnings and forecasts of future earnings can fall significantly. The effect of this risk to earnings is reflected in the often significant falls in equity prices. Because of this, capital invested in equities, save for the dividend income, should not be relied upon to support short term financial security. Stock market risk – the biggest part of a stock’s price is determined by the market’s expectations of future earnings. At times, expectations can become over optimistic and as a result market valuations bear no relation to the ability of the companies or the economy to produce growth. Buying at these levels exposes investors to excessive risk.
At times an investor is unlikely to ever recover the value of the real capital invested. In reality, the only reason why a balanced portfolio of equities is a risky investment is because of the way in which they are priced by the stock market. As far as cash and fixed interest investments, providing economies recover, they are secure short term investments, offering certainty of both income and capital. Three simple rules From the above we can derive three simple rules for investors Equities are not appropriate short term investments. Cash and fixed interest investments are not appropriate long term investments. Over time, equities which are high risk short term investments become lower risk higher return investments. Over time, cash and fixed interest securities, which are lower risk short term investments, become higher risk lower return investments over the longer term. Therefore at a certain point in time equities cease to be higher risk investments and cash and fixed interest cease to become lower risk investments.
Rationale investors with no financial demands on their assets should hold equities as long term investments because they are superior investments with higher long term return and lower long term risks. Conservative investors who are averse to the greater short term risk of equities will hold more lower risk investments than they need. The decision as to what type of investor you are is your decision, not your advisors. The above does not represent all that the investor needs to be exposed to before they or the advisor can assess risk, but it is something that needs to be understood above all. 
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