A few words about risk
What is risk?
The dictionary says: “The possibility that something bad or unpleasant will happen”.
In financial terms, I believe there are two kinds of investment risk:
1. Financial Risk. This is the risk of an investment losing value.
2. Purchasing Power Risk. This is the risk that your investments will not be sufficient to help pay for the rising cost of living in the future.
Both can be bad and impact your financial plan and goals. These are two very different but very important types of risk to understand.
1. Your tolerance for risk is critically important to determine before deciding what type of investments to use in your portfolio. It is one of the most important financial topics to discuss with your spouse, partner, and financial advisor. Be honest with yourself about this. Everyone is ok with risk as long as their portfolio value is going up. How are you going to feel when the value drops 10% in a year? How about 20%? History tells us that this is going to happen at some point.
2. I believe it is unrealistic to want safety from financial risk and at the same time want investment returns that cannot be achieved without that risk. Generally, if you seek ultra-conservative, low level risk, it’s only rational to expect ultra-conservative, low level investment returns. There is no free lunch.
3. If your portfolio shows a substantial increase in a given month (say 1% or more), you have to understand that the increase likely came from investments that have financial risk. Everyone loves to see their portfolio value go up, but if you accept these increases you must also be prepared to accept the declines that those same investments could generate at some time. Understanding why your portfolio value went up is just as important as understanding why it went down.
4. Since I began my career in 1988, the Dow Jones Industrial Average has risen from roughly 3000 to roughly 25,000. During that time, it hasn't gone up in a straight line and there have been some very painful declines along the way. These declines, whether they last for a week or for two years, are reminders that stocks have financial risk. However, historically the market has not gone down and stayed down.
5. There are ads running on satellite radio and TV that are pitching some type of unspecified investment and the ad references the stock market in a negative way, calling it the “Wall Street Casino”. After thinking about that for a while, I concluded the following: In a casino, the longer you stay the better your chances of losing money. History has shown that in the stock market, the longer you stay, the better your chance of making money.
This is not an ad for the stock market or an endorsement of any particular style of investing. It’s hopefully something to think about as you frame your financial picture. My best recommendation is to gather information and think about what level of risk that you’re comfortable with and how your goals fit into that. It also can be very helpful to have meaningful discussions with the important people in your life that are a part of your financial journey. As always, I'm happy to discuss these thoughts with you at any time.