Wealth Management & Financial Planning

Wealth Management & Financial Planning

The Greater the Risk, The Greater the Reward. Or Is It?

That is not always true in life, nor in investing. Driving while intoxicated is a huge risk with very little reward. Diversifying your portfolio decreases risk and arguably increases reward overtime. There are periods of time driven by events or behaviors where the natural order of risk is disrupted.
Morale hazard is an insurance theory that exists when a person feels less concerned over potential loss because the item or property is insured. Not that everyone thinks or behaves this way, but there are people who will take more risk because of insurance coverage.
The natural order of risk is being called into question during the pandemic. As we engage in financial support from the Federal Government and Federal Reserve, individuals and business owners are technically being enabled to take more risk with reduced consequences resulting in potential morale hazard.
Do not take this as a criticism to those responding to assistance being offered during this challenging time. The point is that what we learned in school years ago, still is true today: For every action there is an opposite and equal reaction. As risk is removed from the equation, some people will play looser with the potential outcomes.
The $1,200 stimulus checks were an absolute necessity and Godsend for many families. The amount of retail investment accounts that were created shortly thereafter also showed either the willingness or the ability to invest. One youngster who began to invest said they were playing on “house money.” The fear of losing was diminished because they had no “skin in the game.” Far from accurate, but it was their perception.
The bankers that deal closely with their clients can tell you that the PPP loans were crucial to the survival of many businesses. There were others that took on more risk with the “free money” for the same reason the individuals bought stocks they didn’t necessarily understand.
The Federal Reserve has also responded with a new way to view inflation, giving them more leeway to leave interest rates lower for a longer period. Those low interest rates allow businesses to refinance debt with lower interest payments. For some businesses that is the difference between survival and success.
Some companies are using this as an opportunity to “recap” or use debt to finance huge dividend payouts. Again, the access to capital at very low interest rates is incentivizing people to take on more risk than they did before. If interest rates rise, and at some point, they will, these companies will risk their futures on questionable risky behavior today.
The Leuthold Group reports that 15% of the companies in the Russell 3,000 are now zombie companies. A zombie company is when the interest payments due are less than the profitability of the company. Low interest rates have helped these companies ease the short-term pain. The financial support is both saving those in need and allowing for moral hazard in other cases.
Disclaimer: Joseph Clark is a Certified Financial Planner™ and the Managing Partner of Financial Enhancement Group, LLC an SEC Registered Investment Advisor. He is the host of “Consider This” found on WIBC Saturday mornings from 6-7a.m. as well as three other Indiana-based radio stations. Joe has served as an Adjunct Assistant Professor at Purdue University where he taught the capstone course for a degree in Financial Counseling and Planning. Financial Enhancement Group is an SEC Registered Investment Advisor. Securities offered through World Equity Group, Inc., Member FINRA/SIPC, and a Registered Investment Advisor. Investment Advisory services offered through Financial Enhancement Group (FEG) or World Equity Group. FEG is not owned or controlled by World Equity Group. Joseph Clark and World Equity Group, Inc. do not provide tax or legal advice. For tax advice consult with a qualified tax professional. For legal advice consult with an attorney.

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