Risk-Free?
At first blush, the phrase risk-free has plenty of appeal. It is easy to visualize a stress-free existence with nary a care in the world.
But a risk-free life is an unlivable life. There are always risks, even if you isolate yourself in your home and completely eliminate all tripping hazards.
Has your food been contaminated? How pure is that water? Is radon seeping through your basement floor? What risk is your behavior posing to your family relationships? Will a loose wire burn your house down? What if you have a rodent problem? Attempting to completely avoid risk can lead to paranoia.
Risk-free is impossible. So what options do we have for managing risks that we must accept on a daily basis?
First, we can minimize risks to the greatest extent possible. If there is a high probability of negative outcomes with minimal reward, don’t take a chance. If the roads are sheer ice, stay home.
Second, we can accept the risks. Identify what the worst-case outcome is, assess the probabilities of that occurring, and make a conscious decision to accept that risk. If the roads are clear, proceed to your grandchildren’s basketball game even though there is a very small chance that you may be involved in a crash on the way there.
The challenging thing in accepting risk is that undoubtedly at some point the worst-case scenario will happen. It is also possible you failed to identify the worst-case scenario or maybe the probability of it occurring was higher than you assessed. This is typical with teenagers, but can also happen to seasoned veterans.
Third, we can transfer the risks. In cases where the worst-case scenario is unacceptable even though it is very unlikely, transfer the risk to someone else. You buy car insurance to protect yourself from legal liabilities and to replace an expensive possession that could be converted to worthless on any given day. You are willing to accept the cost of premiums rather than the risk of not having insurance.
The challenge most people face is logically assessing their true risk without emotional distortions.
When it comes to portfolios, our observation is that an individual’s risk tolerance ebbs and flows through an Investment Emotion Cycle©. After two plus years of generally rising stock markets, it is ever-so-easy for traders and undisciplined investors to believe that investment risks are minimal.
It is amazing how easily one can be desensitized to risk when dazzled and distracted by recent excellent returns or fueled by jealousy that other people’s unbridled acceptance of investment risk has paid off. They make it look so risk-free. But it isn’t.
Our disciplined Portfolio SegmentationTM process helps our clients assess their future risks logically and build their portfolios strategically based on their financial plan.
If someone may or will need funds from their portfolio within the next three years, our process is to manage investment risk. We understand that choosing to manage investment risk subjects our clients to other risks (primarily a loss of purchasing power through inflation), but probabilities are heavily stacked in our clients’ favor.
If someone may or will need funds from their portfolio in the next four to seven years, our process is to take a more balanced approach toward investment risk and inflation risk. We accomplish this by increasing investment risk to asset classes that have modest volatility and a high (though not certain) statistical probability of modest returns that can offset inflation risk.
If someone does not need funds from their portfolio for eight or more years, our process is to accept the investment risk that comes with owning companies (stocks). While a streak of positive returns may convince you that stocks are risk-free, they are not. However, over long periods of time this high level of volatility has a high (though not certain) statistical probability of higher returns. The cost is short-term volatility.
As much as a risk-free life sounds appealing, it is an impossible dream. If you or someone you care about would benefit from checking the alignment between their financial plan and their investment portfolio, we are happy to use our forty years of experience to help.
Quote of the week: Benjamin Graham: “The essence of investment management is the management of risks, not the management of returns. Well-managed portfolios start with this precept.”
Securities offered through LPL Financial. Member FINRA/SIPC. Investment advice offered through IAG Wealth Partners, LLC, (IAG) a registered investment advisor and separate entity from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
Stock investing includes risks, including fluctuating prices and loss of principal.
Past performance is not guarantee of future results. All indices are unmanaged and can’t be invested in directly. The modern design of the S&P 500 stock index was first launched in1957. Performance back to 1950 incorporates the performance of the predecessor index, the S&P 90.
Any opinions are those of IAG and not necessarily those of LPL Financial. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. No strategy assures success or protects against loss. Investing involves risk including loss of principal.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
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