What’s the Risk of Not Taking Enough Risk With Your Investments?
During volatile times in the financial investment markets, you might be tempted to “de-risk” your investing portfolio. But, is that really the best approach for accomplishing your long-term financial goals? By trying to avoid risk, are you increasing the chance of financial failure?
A significant part of the difficulty with this dilemma stems from the confusion between the terms “saving” and “investing.” You can’t save your way to sustainable long-term wealth; you also have to invest. When you invest, you’re always taking some risk.
The Four Main Types of Risk in Investing
There are numerous varieties of risk. Liquidity risk, market risk, credit risk, and purchasing power risk are primary for investors.
1. Liquidity Risk
Some investments, such as those in private equity or real estate, can be relatively illiquid. That doesn’t necessarily mean these investments should be excluded from your portfolio, but the risk of illiquidity should be a consideration.
2. Market Risk
When you invest in the publicly traded markets, share prices can fluctuate every day. Again, this risk doesn’t mean you should avoid the stock and bond markets, but you should have this understanding before investing.
3. Credit Risk
When you invest in the bond market, one of the particular risks you face is credit risk, the risk associated with the underlying bond entity being unable to repay you. You’re essentially lending money when you invest in bonds, and you expect that you’ll be repaid. However, there’s always some risk that you won’t.
4. Purchasing Power Risk
Unlike some other forms of risk, purchasing power risk is silent, eroding the value of your investment capital over time via inflation. You’re investing today to have funds for future lifestyle expenses. The primary problem with trying to avoid risk is that you likely won’t be able to maintain purchasing power over the long term.
Understanding Inflation’s Role in Your Investments
If your investments don’t outpace inflation, eventually you can’t maintain your lifestyle. That’s a terrible consequence of trying to “preserve capital” while you’re locking in losses to inflation. Everything you buy costs more each year; your investments should be structured to reflect this reality.
If your investments lose value to inflation year after year, you’re destroying your financial future. Attempting to “preserve capital” by limiting your investment risk likely will fail to preserve your capital when inflation is considered.
Yet, many investors still search for the Holy Grail of investing: good returns with no risk. Just like trying to lose weight by eating ice cream sundaes every day, it’s a fairy tale.
While trying to achieve positive real (inflation-adjusted) returns with no risk is nearly impossible, you can design your investments to have a level of risk that you can stick with over time.
Your long-term financial plan should assume that future investment returns will vary as they always have in the past. Life isn’t linear, and investments aren’t either. Market declines are part of what you should anticipate. They’re essential to the formula that allows you to achieve above-inflation returns over time.
If you can inculcate the reality of short-term market volatility, you can remove the surprise factor. That will allow you to truly be an investor instead of a speculator. Start there. Ready for a real conversation?
Disclosure
Apollon Wealth Management, LLC dba J.E. Wilson (Apollon) is an investment advisor registered with the SEC. This document is intended for the exclusive use of clients or prospective clients of Apollon. Any dissemination or distribution is strictly prohibited. Information provided in this document is for informational and/or educational purposes only and is not, in any way, to be considered investment advice nor a recommendation of any investment product or service. Advice may only be provided after entering into an engagement agreement and providing Apollon with all requested background and account information. Please visit our website https://apollonwealthmanagement.com for other important disclosures.