The risk factor | Investing
By BOB TOOMEY
Mercer Island Reporter Contributor
January 25, 2012 · Updated 1:23 PM
The past several years have been trying for many people planning for or entering retirement. The volatility of the financial markets has created angst and fear as people have watched the value of their capital fluctuate. What these conditions have really driven home is the element of risk in investing; in this case, downside volatility.
The great bull market of the 1980s and 1990s created an environment in which risk was all but forgotten or downplayed. Now the focus is on risk avoidance driven out of fear of capital loss.
Most of us would consider “risk” in the context of potential for downside or loss, in this case capital. There are numerous factors that contribute to risk in investing, not all of which can be easily quantified. Some of the more common “macro” risks include economic risk, geopolitical risk, country risk or industry sector risks, interest rate risk, currency risk, inflation/deflation risk, etc. On a more “micro” level, some of the more common risks include company-specific risks or portfolio exposure risks. All of these factors create volatility in the markets.
A very important aspect of managing risk is for both planners and their clients to carefully assess client attitudes toward risk and risk tolerance. This has an important bearing on the allocation of the assets in their portfolios, which in turn has an important impact on portfolio volatility (or risk). Other ways that risk can be mitigated include diligence in understanding the overall market environment, proper portfolio diversification, reducing exposure to company-specific risks, portfolio hedging, and adhering to a sound financial plan. A sound plan helps to keep a client’s investments on course to achieve long-term goals and reduces the risk of buying or selling at exactly the wrong time (otherwise known as “human emotions” risk).
Risk is part of investing; there is no way to get around this (even bank CDs have risk, albeit small). And there are always going to be major events and surprises that none of us can predict. In the end, the best way to mitigate risk is through proper portfolio allocation, understanding your risk tolerance, understanding and accepting what you don’t know, having a plan and sticking with it, and working with a professional you trust. You might want to ask your financial advisor how he/she is managing risk in your portfolio and have him explain it in a way that you understand and that makes sense to you.
Bob Toomey is vice president, research, for S.R. Schill & Associates, a registered investment advisor located on Mercer Island.