Putting investment risk into perspective

As an adviser, I find that talking about risk can be, well, risky, because it’s a concept easily misunderstood. For example, when working with clients, it is important for me to make clear that understanding investment risk extends well beyond measuring market trends or diversifying a portfolio. It requires the most daunting tasks – taking an accurate and honest assessment of ourselves. And not the self we would like to be or even hope to be; the person we truly are. It means determining the financial and psychological limits of what we can and cannot handle.
This is why assessing risk is, at times, challenging for clients and advisers. It requires brutal honesty and an old-fashioned assessment strategy that, frankly, isn’t trendy. Why is that? First, our short historical attention span ignores hard-earned lessons from the Depression era.Those lessons reflect financial calculations based on hard-won aversions to debt, a preference for saving and delaying gratification, and accepting personal responsibility for one’s financial future.Second, talking honestly about risk doesn’t fit into the cultural ethos of heroic action and spectacular results. We should know better, but books aren’t written, nor movies made or reality TV shows created about people who do an honest self-assessment about risk. That doesn’t seem heroic or headline worthy. We prefer to hear tales of those who bucked the odds and took sizable risks in order to succeed.Peter Drucker writes a great and perceptive line about the issue of risk. “People who don’t take risks generally make about two big mistakes a year. People who do take risks generally make about two big mistakes a year,” he said.Drucker is right about the nature of risk, but I’ve found that it does really matter how and when you make those mistakes.

Risk and rewards

Without understanding the fundamentals of risk, the downside can be considerable, especially for those who are trying to “catch up” after years of neglect or following a personal financial setback.All too often, especially among younger baby boomers, we see people emerge from years of denial about retirement investment planning by taking on too much risk. A retirement future depending on a spin of the wheel “bet” is all too often the metaphorical choice for investors who start too late or don’t understand their true tolerance to risk.An honest assessment of themselves would show that it is difficult and downright impossible to make up for 20, or even 30, years of neglect. Positive and long-lasting steps can be taken but if we learned anything from the financial meltdown of 2008 – or the earlier Internet bust of 2001 – it is that downplaying real market factors and giving little thought to one’s own risk tolerance can create a self-perpetuating cycle of loss.Successful investing relies on a proper match of psychological mindset and a blunt calculation of short and long-term assets and future liabilities. To truly know ourselves is a continual process and that “knowing” is certainly the case when it comes to long-term investing.The Roman epic poet Virgil said that “fortune sides with him who dares.” I would add that in almost three decades of stewardship, I’ve found this to be true – fortune absolutely favors those who dare to truly know themselves.

Tom Sedoric, managing director-investments of the Sedoric Group of Wells Fargo Advisers in Portsmouth, can be reached at 800-422-1030 or tom.sedoric@wfadvisers.com.