The Biggest Risk You Face With Your Investments
If someone were to ask you what you thought is the biggest risk you face with your investment portfolio, what would be your answer? Would it be the increased investment volatility we’ve been seeing this year? Or perhaps it’s the risk of investment losses? Maybe you’d say inflation since it has recently ramped up to highs not seen in decades?
And an even more important question is: what are you planning to do about it?
If you view your number one risk as volatility, you’d probably want to reduce your allocation to the higher-volatile securities such as stocks and real estate investment trusts and bulk up on lower-volatile fixed income investments. If investment losses are your biggest concern then you’d need to take that strategy even further, digging down into each sub-asset class to try to reduce loss risk to some absolute minimum for each and every investment. If inflation is the factor that worries you the most, shifting your portfolio to those investments that you’d expect to do well in an inflationary environment – such as commodities or TIPS or lower-duration bonds – would probably make the most sense. Unfortunately any such adjustments are likely to involve realizing losses, especially if you make them during a period of economic turmoil. And in the end, will these changes provide you with enough money to pay for your children’s education or the retirement lifestyle you desire?
Which brings us to my pick for the biggest investment risk you face. It is simply the risk of not having enough money to fund all the things you’ve been saving for. The many other risks that investors face – volatility risk, liquidity risk, interest rate risk, credit risk, currency risk, counterparty risk, to name a few – are really shorter-term risks that fluctuate over time as economic conditions and investment opportunities change.
Does everyone face this risk? Those who are able to amass enough money during their working years to guarantee sufficient funding for their future plans (think Bill Gates or Mark Zuckerberg) can afford to take zero risk with their savings. If you’re like most people, however, you will need to incur some amount of investment risk in order to achieve at a minimum the growth needed to keep ahead of inflation, especially if you end up living for a long time.
You can manage this risk by breaking it down into its primary components: inflation, longevity, consumption, savings, and growth. You have no control over the first two, but taking an active role with the latter three can make all the difference. You can quantify and prioritize your future goals, determine the amount of savings and growth you’ll need, and then optimize the risk through an appropriate investment strategy. Even if you make changes to goals over time you can always subsequently adjust the strategy.
Creating a resilient lifetime financial plan and an investment strategy that aligns with and supports that plan will reduce the risk of not being able to live the lifestyle you desire both before and after retirement. And by doing so you’ll likely find that you’ll worry a lot less about those other risks (not to mention that economic turmoil as well).