While the stock market was off on a wild ride this past Monday, I took a break from the work day to check out one of my favorite sports websites.
There, I found an “off-topic discussion” headlined “Is it time to go risk-off?”
That simple headline – and the entire lengthy brouhaha that followed it – proved that too many people completely misunderstand risk, as well as the language around it and the impact of it.
With the stock market and economy combining to stir up the emotions around risk, it’s a good time for a refresher course. It’s not that you’re facing more risk now than ever – that’s the common misperception – it’s that so many shades and varieties of risk are in bloom right now.
But let’s start with that “risk-on, risk-off” jargon.
Investment pros intended the terms as a reflection of investor sentiment and behavior. The thinking here is that investors’ appetites for risk rise and fall; they gravitate toward higher-risk instruments when they think risk is low, and move towards safety when they perceive risk being high. The term, therefore, is shorthand for the “risk sentiment” of the market, so that if we are in a “risk-off” environment, it means that investors – on the whole — are being cautious.
It’s not shorthand for “get in/out of the market,” or generally for “buy stocks” or “sell stocks,” yet that is precisely how most people – including plenty of the talking heads from investment companies – use it.
The problem with that usage is that it implies that you can de-risk a portfolio, that there is some sort of risk-free option.
In reality, avoiding one form of risk means embracing others; if you pull all your money from the market to avoid a potential downturn, you run the real chance – especially right now – that sticking the cash in a bank account or bond fund will not allow it to keep pace with inflation.
Ultimately, building a portfolio is about choosing risks so that you can handle the everyday and out-of-the-blue events without reacting emotionally and irrationally.
Doing that – diversifying a portfolio and sticking with it to follow your plan through trouble – requires dealing with the sum of all fears.
It’s not as simple as “eliminate this investment, solve the risk problem.”
To prove the point, here are the fear factors investors are facing today, most of which are present even when they’re not in the headlines:
Losing money in the market: Principal risk or market risk — the chance that a downturn (or bad investment) eats your money — is the big bugaboo. Yes, you can avoid it by eliminating or reducing market exposure, but you’ll be taking a big gulp of some of the other worries in the process.
That’s why all-or-nothing with the market is a bad strategy; there’s a difference between lightening up and bailing out.
Failure to keep pace with inflation: With inflation at its highest level in decades, purchasing-power risk – sometimes considered “the risk of avoiding risk” – is real.
Get too conservative and your savings won’t keep pace with the rising cost of living. That’s not a sudden fast decline like a stock investor sees when the market craters, but it’s a slow, significant loss over time.
Rising interest rates: With the Federal Reserve planning rate hikes, you want to lock in long-term obligations at current rates, but you want the flexibility to reinvest savings at the near-future’s higher rates.
But if you went after higher rates in the past by going into high-yield bonds, you need to be cautious because rising-rate environments increase potential defaults making it that more junk bonds live up to their name.
An insufficient nest egg to last a lifetime: Shortfall risk is about you, personally, more than the market; it’s the chance that you don’t reach your financial goals.
Shortfalls can be caused by being too aggressive and suffering losses, or being too conservative and losing purchasing power, but if every big swing of the market makes you think you don’t have enough saved, the solution may be to save more rather than to overhaul your portfolio.
I need my money soon: This year, I’m facing some wedding expenses for my daughter, but everyone has life events, from having children, to financing college to paying for funerals and everything in between.
Balance your needs against the market, because this “timing risk” is personal. The point of having a portfolio isn’t just amassing money, it’s spending it when needed, so keep short-term needs in focus even as you look at long-term goals.
Politics: Political risk is the prospect that government decisions will damage the value of your investments. This is where policy decisions hit home, and make you decide if you are buying or avoiding, say, infrastructure stocks.
No matter which side of the political aisle you are on, one thing you can agree on is that divisive politics are not going away, and that political decisions have consequences. It’s another reason to diversify.
Covid-19: The pandemic still affects our everyday lives, and that’s not likely to change soon. The question for investors is whether you anticipate a return to shutdown mode, or how long it will take for the virus to become endemic, dealt with on an individual level – like a flu – rather than a national level.
If you think Covid will be a non-factor – or at least controlled to where it is not in the daily headlines – within three-to-five years, then it only deserves your attention when considering short- and intermediate-term investments.
Trade wars/societal risk: An extension of politics and special-situation risk like Covid, there are legitimate fears over tensions in the Ukraine, relations between the U.S. and China and more.
It’s possible to like the opportunities you see in emerging markets, but to temper that enthusiasm due to global macro concerns.
Like all risk factors, this can lie dormant until an event flips the switch. The more you factor these potential events into your thinking, the easier it is to ride them out.
Chuck Jaffe is a nationally syndicated financial columnist and the host of “Money Life with Chuck Jaffe.” You can reach him at firstname.lastname@example.org and tune in at moneylifeshow.com.
Copyright, 2022, J Features