The financial services industry has produced an endless variety of risk tolerance questionnaires, all in an effort to help people understand how much risk they should be taking when it comes to their investments.
Of course, the media also chimes in on the whole “risk” question on a pretty regular basis, usually by telling anyone who’ll listen that the economy is in either a “risk on” or “risk off” mood. “Risk on” being those days when everyone is shedding their savings accounts in favour of stocks, high-yield bonds or real estate. And “risk off” referring to those times when we’re all tripping over ourselves to get out of stocks and bonds as quickly as we can, and into the “safety” of savings accounts or government bonds.
If you were to ask those investors who cash in their growth assets as soon as a “risk off” time rears its ugly head, exactly what their strategy is in doing so, most would say something along the lines of “I just want to keep what I’ve got,” or the even more ominous: “I’m trying to keep what I’ve got left.”
Let me give you a personal example, which got me thinking recently about the real meaning of “risk.” I was talking to a friend about his experiences in the 2008 market crash. He was complaining that his advisor took too long to get him out of stocks when the bottom fell out of the market. Apparently, his advisor was spouting some nonsense about sticking to their long-range plan and holding steady through the crisis. So he fired his advisor, turned all his equities into cash, and has stayed there ever since. Or as he put it: “at least I kept what I had left!”
Unfortunately, the facts tell a very different story. While converting his stocks to cash may have succeeded in bringing down my friend’s blood pressure, it also meant disposing of 40% of the value of his portfolio, precisely because he decided to sell at the worst possible time – after his stock holdings had already plummeted. To make matters worse, because he can’t afford to live on the paltry interest his “safe” investments are paying, he has also had to spend another 20% of what he had left just to cover his living expenses.
Put another way, in his quest to “avoid risk” and “hold onto what he’s got,” my friend has effectively wiped out more than half of the wealth it took him a lifetime to save. As a result, he’s been forced to come out of retirement and go back to work as a consultant, just to keep himself and his family afloat.
To most of us, what this fellow did would seem to fall into the category of taking prudent steps to reduce his risk profile, protect his wealth and make his portfolio safe. Yet the reality of his current circumstances proves that all he really did was miss out on the inevitable market rebound, trade in a profitable dividend stream for an interest rate that isn’t even enough to cover his current expenses – and make sure that his retirement portfolio will be incapable of keeping pace with inflation and the cost of living increases he’ll be facing for the next 10, 20 or 30 years.
Now, I have no desire to play “I told you so” when it comes to this investor’s situation. The crisis of 2008 claimed many victims, as people struggled to make the right decisions in the heat of the moment. But what I am trying to do is dispel once and for all the myth that is stuck in the psyches of so many otherwise intelligent and informed investors – namely, that one end of the investment spectrum is “risky” and the other is “risk-free.”
The fact is, investors are taking a risk whichever way they choose to go with their money. If you decide to keep all your money in a savings account (or under your mattress), the risk you’re taking is the absolute certainty that, one day, the buying power of all that money will be more or less completely wiped out by the twin threats of taxes and inflation. On the other hand, if you decide to put all your money in the stock market when you know you might need to recover income from your portfolio in the near future, then you’re running the risk that the market could drop 40% in value right when you need that money, and you might end up having to sell the stocks you shouldn’t be touching just to cover your daily expenses.
The bottom line is, as investors, we are never truly “risk-free.” And we do ourselves a great disservice when we believe that we are making “risky” or “risk-free” decisions, when what we’re really doing is simply managing risk in whatever strategy we decide to adopt.
GICs and savings accounts are great places for short-term cash requirements such as income. Stocks, on the other hand, are unsurpassed when it comes to generating long-term returns net of taxes and inflation, and building a rising dividend stream over time. Each course of action comes with its own brand of risk. Each has its own reward.
Instead of making decisions based on how “risky” you feel they might be, a better way to build your portfolio is to ask yourself: Do you have a plan? Are you confident enough in what you own to stick to that plan even when it is sorely tested? And if you’re taking advice from a professional, do you completely trust the source where that advice is coming from?
If you can answer “yes” to all three of these questions, then maybe you’re at the low end of the risk spectrum after all.
Alan MacDonald is an investment advisor with Richardson GMP Limited. Alan helps investors with over $500,000. of assets make smart decisions about money. He is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.
For more information please visit www.alanmacdonald.ca or email Alan at Alan.Macdonald@RichardsonGMP.com.
All material by Alan MacDonald. Alan MacDonald is an Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates.
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Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.
