Risk. It’s a word that’s used a lot in the investment and financial planning world. But what does it really mean?
In the typical investment/planning context it too often refers to market risk. But market risk is only one of many risks that we take.
There is inflation risk when we think cash is safer than investments – it may be over a short period of time, but it’s not in the long run because inflation is a cash killer.
There is longevity risk when we think that our choice today to save less or be too conservative won’t have an impact because we just know we won’t be the one to live to see 100, or be the one to need long term care.
There’s concentration risk. I’ve worked with business owners that have nearly all their assets in their own business and don’t see it as a risk at all (familiarity bias). I’ve seen the same with land/real estate owners.
There are lots of other kinds of risks too, but the point is made…
All this reminds me of a conference session I attended in February. Holly Thomas was the presenter for one of my favorite sessions. One of the takeaways from her presentation was that we are NOT risk averse – we take a lot of different kinds of risk in stride all the time! We are LOSS averse. Here’s her example:
Would you prefer to receive a 100% gain on $3,000?
Would you prefer to receive an 80% gain on $4,000?
Most people have an immediate reaction that 100% gain is better. While a 100% gain sounds better, the math is in favor of an 80% gain on $4,000 (which would be a $3,200 gain!).
Still not convinced, let’s flip it:
Would you prefer to take a 100% loss on $3,000?
Would you prefer to take an 80% loss on $4,000?
The math is still the same, but feels different, right?
That’s why during weeks like this it’s easy to overlook the conversations around risk tolerance and time horizons. We become paralyzed by the media constantly streaming negative headlines. We become fearful that this time is different.
We are often ruled by emotion and our own familiarity biases. When we are familiar with something, it doesn’t seem as risky. When markets are volatile, as they have been lately, our emotional biases rise to the forefront. It’s normal. It’s ok. Recognize it for what it is. But don’t abandon a well-developed plan.
If, on the other hand you don’t feel you have a well-developed plan, you should seek qualified, professional advice on how to align your financial plan with your goals and risk tolerance (p.s. - we can help!).
One of my biggest tasks as a Financial Planner is to help take emotion out of financial decisions. Risk is inherent, but it can be managed in a variety of ways. Another big task is education. It is up to me to work with clients to develop an appropriate risk-adjusted investment portfolio using low cost, evidence based strategies. That doesn’t mean that volatility and market losses don’t happen; it means our approach is built to recognize that market cycles come and go.
And don’t forget - investments are only part of the full picture. Consistent contributions, appropriate distributions, tax efficiency, estate planning, benefits optimization, debt management, proper insurance coverage, and helping build great habits to achieve their most important goals – THAT’s what a good financial plan is all about.