As financial advisors it is our fiduciary duty to ask our clients to step outside of their comfort zone in order to secure their financial future and achieve their goals. When it comes to the long term success of your money, not taking risk might be the biggest risk of all.
Many self-declared risk-averse investors believe that putting their money into stocks (or equities) is too risky. Truthfully, not investing some of your portfolio in equities is pretty risky too. The slower growth of bonds, T-bills and other low-risk investments may not financially prepare people for their retirement because the growth of their portfolio may not outpace that of inflation. Then what happens? Investors trade the actual security of their retirement for the perceived security of investing in lower-risk options.
Understanding risk in investment begins with accepting that the market itself has already done a lot of the worrying for you. Markets are highly competitive, which means that new information is quickly built into prices. Instead of trying to second guess the market, you work with it and take the rewards that are on offer.
Many people who fear taking risk do just that when they invest without the help of an advisor. They gamble on individual stocks, they rely on forecasts, they chase past returns, the do no rebalance their portfolios to take account of changing risks and they run up unnecessary costs and tax liabilities.
Your goals help to define key risks, the right risk management and how to monitor performance. For example, a primary goal of retirement planning is to provide consumptions in retirement using the money that you have accumulated during your career. A key risk is uncertainty about how much consumption can be sustained…In other words how much money can you spend when there is nothing coming in? And how long will it last? Managing this uncertainty requires investors to look at their investment performance as the unit of measurement by which this uncertainty is either increased or reduced. So, as advisors, the way we monitor the investment performance is by adjusting the risk to reduce the uncertainty of achieving sustainable consumption.
Even the most risk-averse people take risks on a daily basis. Crossing the street, driving a car, exercising. All of these activities have some degree of risk. But, we take them, since the alternative would make it impossible to go about our day-to-day lives. If it would be impossible to fund your goals without assuming a certain amount of risk, then logic would tell you that you’d need to take that risk in order to meet your objective, Right?
Then there are the big decisions like choosing which college to go to, choosing your career, getting married and having children. These decisions involve tremendous amount of risk and yet, most of us make them during the course of our lifetime.
How do we go about making these decisions? We weigh the alternatives, consider consequences, balance our emotions with our intellect and look at the short term and the long term effects of our choices. Sometimes, we ask advice from others to help guide us. This outside advice can help provide us with an objective assessment of the potential risks and help us see things we might not have noticed or considered on our own.
In investment, this is the value that a good financial advisor can bring—not only in understanding risk and return and how to build a portfolio but in knowing the specific needs, circumstances and aspirations of their client.
It would be great if we could watch our investments soar without assuming any risk. But the reality is that without risk, there is no return. An investor’s chances of a good outcome are far greater when they use the resource of an informed advisor to guide them through the ups and downs. Risk and return are related. But not all risks are worth taking. The process of working this out starts with not trying to do it all alone.