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As one of my stated missions is to help people better understand their money, this column along with our weekly radio show and blog often examines the world of economics through the lens of everyday life. Last week, our team had an opportunity to present at Noblesville Baptist Church where a straightforward and very important question was posed: “Joe, what is risk?”
That question is a reminder that a simple term like “risk” can be very confusing. Working with families, we use the Fiduciary Focus as a guiding checklist. We believe in maintaining a dedicated and intentional focus on risk and volatility, fees and expenses, taxes both today and tomorrow and obtaining a real return.
At Noblesville Baptist, we asked attendees, “Are stocks risky?” Naturally, everyone said yes. When asked if bonds were risky, half the attendees said yes. Yet when we asked if certificates of deposit (CDs) were risky, no one said yes. I thought, “Houston we have a problem!”
Stocks are not risky. Before you put this column down, please trust me and continue reading. Risk naturally conjures up a negative outcome. Humans simply don’t think of risk in positive terms. Consider these risks: She may say no when you ask her out. You might have a car wreck. You could fall and hurt yourself. You could lose your money. None of these scenarios are positive. Stock values can indeed decline but they can also rise. Stocks are inherently “speculative” not risky. In the world of finance, risk is defined as getting an unexpected result, whether good or bad.
During the Great Depression, FDR needed money back in the banks, so in his famous fireside chats he replaced the word speculative with risk. The change in verbiage caught on and continues today. For example, we use a risk tolerance test with the families we serve, but the test doesn't address how a family will respond if their account’s valuation increases. Rather it looks at behavior through the lens of a negative event.
The chart I used to address the “what is risk” question actually focused on volatility and provided a 30-year history of the markets. I started my career two weeks before the October 1987 crash. Since then, I’ve witnessed other times of volatility including the Tech Wreck of 2000 and the Great Recession of 2008. But over time, the market has marched higher. Interestingly, fixed income investments (think CDs) have also experienced volatility over time although not as extreme at any one point. Are stocks and bonds risky? They are speculative but also volatile, and various forms of risk can lead to volatility.
CDs are not volatile but they are risky! Everyone focuses on risk of principle but don't forget other risks that could threaten your financial future. Reinvestment rate risk, credit risk, longevity risk, purchasing power risk, market risk, concentration risk, business risk, currency risk and about six to ten other risks also merit consideration. Risk incorporates much more than lost principle. Get to know your money and your risks.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.[/vc_column_text][/vc_column][/vc_row][vc_row][vc_column offset=”vc_hidden-lg vc_hidden-md vc_hidden-sm”][vc_widget_sidebar sidebar_id=”sidebar-main”][/vc_column][/vc_row]