July-August Newsletter

What is Risk?, Part I

For our articles in July and August we are going to dig a little deeper into some different risks associated with investing. In this month’s article, we are going to look at some common risks during the accumulation stage where building up one’s assets is of primary importance. Then, for next month’s article, we will look further at risks associated in the retirement income planning stage where consistent income is of utmost importance. When you hear the word ‘risk’, what types of thoughts come to your mind? Think about this for a second, because we could ask 20 people and probably get 20 different answers.

Risk, by definition, is the potential that a chosen action/activity will lead to an undesirable outcome₁. So for some, risk might mean a loss of principle, while for others it may mean not achieving a desired financial goal. In every financial decision we must choose between different types of risks. For example, does one take on more risk if they choose to invest more conservative vs. more aggressive? Most people would answer this question by saying there is more risk associated with investing aggressively; however, this is not necessarily true! What is this person’s time horizon of when they need the money? How much do they need it to grow? What is their goal for this money? If a person is younger, near retirement or retired and wants some part of their money to grow for their retirement, then they would probably be taking more risk if they invested conservatively. Why, you may ask? Well, being more conservative is less likely to produce returns that will exceed inflation over time, thus reducing their future purchasing power. They would also be taking the risk of missing out on higher equity returns that, historically, produce higher returns over longer time horizons than bonds, cash or CDs. In this described situation, it is true that this person might experience more volatility (up and down swings in asset values) during shorter time frames within their investment timeline. However, we could easily conclude they aren’t taking more risk when it comes to reaching their goal of growing their assets to provide future income that will outpace inflation vs. being conservatively invested in funds that historically have little chance of enabling them to reach their goal. So, it is always important to look deeper at the underlying scenario to properly decide which type of risk to take.

Now that we’ve laid the baseline of what risk is and realize that there are different risks associated with every financial decision, let’s look at a few of the more common risks many investors think of when trying to accumulate assets for retirement (or any other financial goal). One risk that most everyone is familiar with is what is called ‘Market Timing’ risk. This is basically tied around the old philosophy of investing that ideally one wants to “buy low and sell high”. This is ultimately how you profit when investing and should be the goal every time when making an investment decision. The problem though is that none of us have that coveted ‘crystal ball’ that tells us which direction the stock markets are going to move and when. Because of this, the average investor typically falls into the trap of letting their emotions get the best of them. They find reasons to not invest because they want to wait until “things get better”. This is usually caused by the fear that they will lose money and they don’t want to take that risk. This has been very present over the last 3 years as investors continue to pile billions of dollars into money market funds, CDs, savings accounts and bond mutual funds while simultaneously pulling billions of dollars out of stock mutual funds—this has been during a time where the S&P 500 has risen over 100%! The risk many individual investors have taken over the last year is safety (by conserving principal) over potential gains and it has cost many a lot of money. For those accumulating assets, this is potentially causing further long-term risk to them that they probably aren’t even aware of because they are losing the time value of money to let their assets accumulate and grow. The key, in our mind, is to stay focused on your goals even during the difficult economic times. History has shown us time and again that those who stick to their plans and don’t sit on the sidelines when things don’t necessarily feel good are the ones that typically prosper over time.

A second risk investors accumulating assets must decide on is how they invest their money, better known as Asset Allocation or Diversification risk. Some decide to invest all their money in individual stock(s). This has the potential for a very high risk-reward ratio in that the company one owns could do really well and make big profits. This could also go the exact opposite direction where that particular stock one owns drops dramatically. One need not look far for examples of deep losses (sometimes company bankruptcies) by investing in individual stocks—BP after the Gulf Oil spill, GM during the economic crisis, Lehman Brothers and Bear Stearns in 2008, Enron in the early 2000’s just to name a few. Another way to allocate one’s money is to be a buy and hold investor where one invests their money and just keeps it in the same funds no matter what. We’ve seen the potential problems with this as the S&P 500 is basically flat for the past ten years and the NASDAQ is still down over 40% from its high in 2000! We feel that the best way to try and minimize this type of risk is through strategic money management where we are constantly monitoring the various sectors of the markets. History has shown us that different sectors of the market are always moving from being the leader to being the laggard, so we try to capitalize on those market movements over time.

A final common risk we see those in the accumulation phase make is a lack of planning. The risk here is that too many haven’t sat down to really think about what they want to accomplish and the best ways to achieve their goals. There is an old Proverb that says “He who fails to plan, plans to fail”. This can ring true when it comes to planning for future financial goals. For example, if a couple wants to save for their retirement and for their child’s college fund, then wouldn’t it make sense to have a plan on how to best fund each of those? To maximize a situation like this it would be prudent to look at how taxes might impact their savings, how long a time frame they have to save, how much resources they have to invest for each goal or which goal is the primary importance. The problem we see or hear about far too often are of situations where someone doesn’t plan because it is too time consuming, too complicated or they are worried what they might find out. The risk they don’t realize is that the longer they delay, the tougher answers they are going to get to the questions that inevitably need to be answered!

We are just at the tip of the iceberg when it comes to all the types of risks associated with the accumulation phase of one’s investing life. There are many others—some more universal and others that are particular to individual situations. The important thing to remember is that the risks are always present. There is always an opportunity cost of making one decision over the other. Part of our role is to help you have the proper information to make informed decisions so you aren’t taking on any unnecessary risk for what your goals are. Stay tuned for next month’s article where we will continue our discussion on risk, but with a more focused look at common risks for those in or near retirement. As always, if there are any questions or concerns you may have for your planning situation surrounding this topic (or any others), please don’t hesitate to get in contact with us. We are your financial resource to help in any way possible.

Steve and Eric

Updated Look to Newsletter

As you can see, we’ve revamped the look of our monthly newsletter. We’ve been working diligently this year to bring out this fresh, new look to continue providing top notch service and communication avenues to you, our clients. Our goal was to be able to provide a more accessible and user friendly newsletter while still keeping all the relevant information we have provided in the past. We also tried to put together this new formatting that will make it even easier for you to forward a newsletter on to your family, friends or co-workers as topics relevant to them are written that you feel would be valuable for them to read.

As you get a chance to scroll through the new layout for this and future months, please give us feedback on your thoughts. Ultimately, we want clients to be able to navigate each newsletter easily and have it in a format that is pleasing to you. So comments, good or bad, are welcome as we continually try to re-fine and perfect our communication outlets to clients. Thanks in advance for you feedback and happy viewing!

Did You Know

1. Half and Half- 153.4 million Americans are in the civilian labor force (i.e., either currently working or seeking work). 158.3 million American are either too young to work or are retired₂

2. Not All the Same Size- The 10 largest US states (in terms of economic size) make up 55% of the total US economy. The top 3 states make up 29% of the overall total₃

Stay Positive and Believe in Yourself!
“Confidence comes not from always being right but not fearing to be wrong” – unknown author

“The sky has never been the limit. We are our own limits. It’s then about breaking our personal limits and outgrowing ourselves to live our best lives” – unknown author

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