Intangible Risk

Investing in the stock market is not a free lunch. You take risk in order to get a reward. If anyone else tells you there is free money out there, then it is very likely a scam. Risk is something you not always see.

When you start to invest, it is hard to understand what risk is. Very often, people call volatility the risk they take. Volatility are the prices that move up and down. When they are down, the portfolio is worth less than they paid for. Is that risk? Not to me, that is a paper loss.To be fair, it took me quite some time to reach that point. It is no fun to see investments that are worth less than the initial price.

What is risk then?

To me, risk is not getting the expected result. You make investments with a given goal. For a lot of people, the expected result is a positive return on their investments, higher than the rate of inflation. There are people that even put a specific number on this, like 5pct or even more per year. Not everyone makes it explicit like this. It might be more general like maintain my lifestyle when in pension.

What are the items that can endanger your goal?

Loosing everything

The asset you invested money in is now worth zero, nada, nothing. That is a risk. All your money is now gone. This risk can be mitigated by investing in a well diversified portfolio. The likelihood of loosing all is then limited. If that would happen, there are far worse issues ongoing.

Loosing when you are forced to sell

This would be a case where you are having a high expenses and your only source of money is your investments. In that case, you have to sell the assets. A paper loss can become a real loss at that time. A counter measure is to set aside an emergency fund to take care of the foreseeable needs for money. The future can not be fully foreseen. I would think that here you have to accept a certain amount of risk.

Investing at the all time high of the market

As I believe that in the long run the companies that make up our economy are creative and responsive, I do not see this as an issue. It could be that you invest at a local high, that will be followed by  a new high a few years later. Especially if you reinvest the dividends from these companies.

When in buildup phase, the logical action is to dollar cost average. This way, You buy the lows and the highs.

Another action to take: rebalance your portfolio on regular basis.

A too conservative portfolio

People have a problem with paper loss and big drawdowns, thus they keep all money in a savings account. This is a very big risk. There are very long periods where the interest on a savings account can not keep up with expectations, let alone with inflation. You then risk not to reach your goals.

Today in Belgium (Jul 2016) the interest is lower than inflation. Keeping cash means loosing money. Do I say: no savings? Hell no!! See the point of emergency savings above

Asset Allocation is important. Find one that matches your goals and risk tolerance: what paper loss can you sustain. If your portfolio is too aggressive, then you can be lured into bad behavior by selling at the bottom.

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By taking the above elements into consideration, you can reduce the risk of your investments. You can give yourself a good probability of success. Especially if you are in a wealth accumulation phase.

 

The last risk might be a too high expected return of your portfolio. Do not expect the returns to be the ones from the good periods like 2009-2015. This is not realistic, This is dreaming.

What is risk for you?

 

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11 thoughts on “Intangible Risk

  1. I like how you reframed risk here. You’re right that volatility is not really a risk because it’s baked in and par for the course. It’s like saying that the risk is that it might be hot in the summer. It *will* be hot in the summer — those are the natural conditions. I do see a lot of PF bloggers pinning their plans to overly optimistic (in my opinion) rates of return, and I hope for their sake that they have a back-up plan.

    Liked by 1 person

  2. Great post, there are a few additional types of risk that I worry about. 1.Currency risk is really big. Being Canadian, our dollar has fallen against all major currencies. 2. Liquidity risk is another one that I am very aware of. Some ETF’s or stocks have very low trading volume and it can be hard to sell out of a losing position.

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    1. Indeed, these 2 risks are important as well,especially in times of stress, liquidity could be limited.
      My currency risk is baked in the etf as they all quote in eur. For now, i worry less: about half of my asets are EUR denominated, the rest is mainly Usd and then some.

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  3. Good perspective on investing at all time highs. Some folks may hear that and get spooked, but it gives no indication of where the market is going next and it very well could continue a climb. Especially for long term investors, don’t bother trying to time your next contribution.

    Thanks for the post!

    Liked by 1 person

  4. No pain, no gain. No risk, no reward. We all get paid to take on risk.
    Risk-free assets now have negative nominal interest rates in many countries, as you stated. So, not taking on risk might be the greatest risk of all because you’ll erode your purchasing power. So, what is risk-free short-term might be the riskiest of all, at least long-term. It’s all a function of the horizon, how long you can ride out a potential drop in the stock market, for example!
    Cheers!
    ERN

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  5. Thanks for sharing! We are just exploring the ins and outs of investing, and getting past the fact that it’s scaaaaary. Your definition of risk and the mitigating measures are really refreshing!

    And you’re right: it’s not a risk if you know it’s going to happen. Years spent as a risk analyst and never even realized this is also true for investing.

    Liked by 1 person

  6. Hi Amber Tree,

    For me, I have an aggressive growth plan and to reach my financial goals at my set deadline, I cant afford to play too conservative.

    Occasionally, I do like to challenge myself with some risk tolerance training to up my risk level as I see that it will be a useful skill in the future. Excellent post!

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  7. Risk is definitely not the same as volatility. I’m happy for volatility as that creates opportunities to buy at a low price! Risk for me is what’s the danger of the investment going bust, or the growth being less than inflation over the long term. As long as the companies that we are investing in sustain-ably increase their profits & dividends faster than inflation over 10+ years then I’ll be happy with that.

    Tristan

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  8. Hi abt,
    I think you have it right – I think volatility is the statistical variation of an investment / asset’s change in price / total return, whereas risk is a measure of your ability to meet your goals in a given timeframe.

    So if you had a savings target to meet in 30 years time; investing in (volatile) stocks probably isn’t risky since over that time they will likely increase in value. However putting that money in (less volatile) cash hidden in a mattress is more risky since inflation may reduce the value of that cash over a thirty year period.

    Conversely risk in the form of stocks is pronounced with shorter time frames – if you invest money in the stock market today in order to buy a house early next year; it’s very risky because stocks are volatile and may well lose their value in a 6 month timeframe.

    Great article, I enjoyed reading it.

    Best wishes,
    -DL

    Liked by 1 person

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