Be realistic about risk

I know I have a natural bent towards pessimism, but does it really make sense for everyone else to be quite so optimistic? Ask me to list the risks to the global economy at the moment and as regular readers will know you won't be able to shut me up for hours. Yet, despite the terrorist attacks on London last week, the FTSE was back at a three-year high and, in the US, where you'd have thought the imbalances in the global economy would have made most people a little jittery, the VIX index (a measure of equity-market volatility and hence of perceived risk) is at a multi-year low. The market as a whole appears to think that real risk has pretty much disappeared from the world. But it really hasn't. In our cover story this week, we look at what kind of risks face us today.

Historian Niall Ferguson has recently been pointing to the political and the financial parallels between now and the period before the outbreak of war in 1914. This too was a period of extraordinary optimism. Despite fast-rising commodity prices (coal, effectively the oil of the time, was soaring in price), inflation expectations were low, and, despite obvious political tensions, overall risk perceptions appeared to be declining. Globalisation appeared so advanced and the world's economies so entwined as a result, says Ferguson, that no one in the financial industry could really imagine any one country wanting to bring the growth of world trade to a halt with a war. So complacent were the markets that the first mention of the possibility of war in the financial press came on 22 July 1914. Only then did bond yields finally start to rise. Yet Archduke Franz Ferdinand had been shot a good three weeks before.

It seems amazing in hindsight that a world could be so over-optimistic, but one can't help but wonder if we might not be making some of the same mistakes all over again. We face some similar risks to those of our great grandparents and a raft of other risks, both political and financial. And we aren't accounting for them when we invest. The problem is that most potential crises never happen, so liquidating your portfolio because, say, resource competition is hotting up a bit too much for comfort between the US and China, seems a bit silly.

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So what can we do? The answer as ever in MoneyWeek is to make sure you have insurance. Have a little gold in your portfolio, have a little silver, and try to stop yourself taking out too big a mortgage. Just in case.