For some investors, risk is a dreadful word. Risk is associated with downside and loss. Good if it can be mitigated; better if it can be avoided; best if it can be eliminated altogether.
If asked to visualize their perception of risk in canine terms, the risk-averse investor’s image of risk may look something like:
This attitude may stem from learned behavior (perhaps from parents or grandparents that lived through a life-altering event like the Great Depression of the 1930s) or from personal experience (maybe by having lost sizable sums during the Global Financial Crisis of the mid-aughts).
For other investors, risk is perceived as a necessary evil. They know that compounding is an important factor in capital accumulation.
To facilitate compounding at a satisfactory rate, they accept the risk (as discomforting as it may be) that comes with their targeted rate of return.
Fewer people associate risk with opportunity. The idea of risk as an attractive feature of the investment landscape may seem strange.
However, learning to view risk through a lens of opportunity can be good for your wealth and important for your peace of mind as an investor.
Being able to envision risk as something with beneficial aspects – though requiring regular attention and sometimes tricky to manage – is a more desirable orientation. The risk-tolerant investor’s view of risk (again, in canine terms) might be pictured like this:
In his latest client memo, the professional investor and author Howard Marks, the co-founder of Oaktree Capital Management, talks about “the indispensability of risk”. Here are a few illuminating quotes on the nature of risk:
- As five-time world chess champion Magnus Carlsen put it, “not being willing to take risks is an extremely risky strategy.”
- Investors must accept that success is likely to stem from making a large number of investments, all of which you make because you expect them to succeed, but some portion of which you know won’t.
- Not every effort will be rewarded with high returns, but hopefully enough will do so to produce success over the long term… refusal to take risk in this process is unlikely to get you to where you want to go.
- You have to sacrifice certainty (as an investor) but it has to be done skillfully and intelligently, with emotion under control.
- The risk inherent in not taking enough risk is very real. Individual investors who eschew risk may end up with a return that is insufficient to support their cost of living.
Marks’ words are helpful in validating the need to take risk and in reminding us that, while some investments are likely to fall short of our return expectations, a willingness to bear risk in an intelligent and controlled manner facilitates investment success.
The last point from the above list seems most relevant to those who are approaching, or in, retirement – and thinking about longevity. It is worth restating: the risk inherent in not taking enough risk is very real.
The financial planning process is a particularly useful way to assess portfolio risk as it facilitates:
- understanding the current level of risk you have
- calibrating the degree of risk you need
- knowing when to adjust other parts of your financial plan if the risk in your portfolio changes suddenly
For those who have a high level of concern when it comes to taking financial market risk, we find that our suite of financial planning tools can help improve risk visualization and raise the comfort level for maintaining a level of risk that supports a financial plan over the long term.
If you envision bared teeth and sharp claws when you hear the word risk, please let us know.
We’d like to use our expertise and planning tools to begin shifting your perception of risk, and to help you see it as a beneficial and desirable aspect of investing and a necessary part of your financial plan.
-RK