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Are you taking too much capital risk with your investments?

I think it’s quite possible that a lot of investors are taking on too much capital risk with their investing at the moment.

The ideal scenario is that you are aiming for asymmetrical returns where the chances of good returns are much higher than the chance of poor returns.

I fear that investors are taking on a lot more risk for the high chance of low returns.

Just look at Transurban Group (ASX: TCL) and Sydney Airport Holdings Pty Ltd (ASX: SYD), their share prices have gone up 32% and 24.7% so far in 2019. These are impressive gains from defensive businesses that were already valued highly at the start of the year.

The same could be said about some of the seemingly defensive real estate investment trusts (REITs) such as Goodman Group (ASX: GMG) which is up 45% and Charter Hall Long WALE REIT (ASX: CLW) which is up 25.8%.

The main risk I see is that investors are paying a very high price today for a bit of yield when their capital could easily go backwards by 10% or 20% quite quickly. 

‘Yield’ shares are indeed worth a bit more in the lower yield environment we find ourselves in. If interest rates stay this low for many years then shares are worth quite a bit more than the historical average.

But, share prices have a long-term connection to the performance of the earnings of the business. Transurban and Sydney Airport will both have to perform well to justify these prices.

I fear we may see a repeat of what happened to Telstra Corporation Ltd (ASX: TLS) between 2014 and 2017. People bought Telstra for the yield, the share price rose, but then shareholders suffered much greater capital losses compared to the decent income they were getting.

Foolish takeaway

I think we have to be wary of the prices being paid for some of the most recognisable defensive names. It might take months or even a few years to tell whether investors today were right to invest, but I wouldn’t want to make that bet.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited, Telstra Limited, and Transurban Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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