Understanding Risk in Investments
Often, the term risk comes with a negative connotation. I see it a bit differently. First, we all take risks daily. Waking up and getting out of bed, or not getting out of bed, both come with their own risks, and that continues throughout the entirety of each day.
Understanding the Risk You Are Taking
Risk and life go hand in hand whether we want to accept it or not. I believe that risk is not something negative, but simply something that needs to be understood to properly assess if it is worth taking said risk or not. For example, we know that each day we get in our cars, there is a risk of getting into a wreck, yet, more days than not, we gladly hop in our vehicles, hit the road, and get on with our day. On the other hand, during a whiteout storm, we may be less likely to venture out. Both entail carrying the risk of being in a vehicle, yet one scenario has a higher chance of something undesirable happening than the other. Without understanding the risk, how could we possibly assess if it is “worth it” or not?
Risks in Investments
This is absolutely the case when it comes to risk and investing. The whole reason people invest is to grow their assets and make more money. This does not come without risk. In fact, the return earned is what pays you for taking that risk. In the absence of risk, the only gain to be had would be a risk-free return (think savings accounts, etc.). While there absolutely is validity to having funds in a savings account, the entirety of one’s savings likely should not be held there as it will lose buying power against inflation over time. The exact opposite of what most folks are looking to accomplish for their larger picture and overall situation.
Two Types of Investment Risks
When it comes to investing, there are two kinds of risk. The risk you are comfortable taking (IE your desire), and the second is the risk you can afford to take (IE ability). To elaborate, your risk desire boils down to how wild or mild of a ride that you are comfortable being on, and your ability to take risk deduces to “how much can you afford to lose” (before your financial security is no longer on solid ground, or out the window entirely).
In some cases, one’s desire and ability can be in lockstep, yet more often than not, a discrepancy between the two is present. This could be a scenario where someone is very comfortable going through wild swings in the market, seeing great highs, as well as substantial lows, but the ability to take risk is far less. The inverse of this is also quite common in that someone may be very risk averse emotionally (desire) but has the ability to take a substantial amount of risk. It is imperative that both you and your advisor have a very clear understanding of this. I would add, this understanding needs to exceed the standard, subjective descriptions that are frequently used (IE “I’m a moderate investor”). I have seen more situations than I can count, where subjective descriptions were the base of these discussions, and typically lead to underwhelming/frustrating results all the way to catastrophe in some cases.
Maintaining Appropriate Risk Levels
While I have explained risk as it pertains to desire and ability, it is important to note that these tolerances can change. This could be driven by something happening in an individual’s life that warrants change, or on a more macro level such as a world event taking place. Point being, risk is not something that can nor should be discussed once, etched in stone, and never revisited. I am not advocating for constant change in one’s investment approach, strategy or holdings, but rather, the necessity of a constant pulse for both your individual situation, overall environment, and progress in maintaining your financial plan. This is undeniably a key component to maintain with your financial advisor if you wish for your plan to be successful.
While we are all in a constant state of taking risks, the epicenter of our professional world centers around risk, understanding it, and making the determination of how much, and when it should be taken at any given point. If we can be of some assistance in bringing some additional clarity on this to you, we would love to have the conversation. Too often, the time and attention provided to this is inadequate at best, and we are here to be the exception in that regard.
This is being provided for informational purposes only. The views expressed are those of Silver State Wealth Management and do not necessarily reflect the views of Mutual Advisors, LLC, or any of its affiliates. Investment advisory services offered through Mutual Advisors, LLC, DBA Silver State Wealth Management, an SEC registered investment adviser.
