Now is the time to embrace all the risks
Years ago I stayed at a hotel on the Las Vegas Strip where a flashing message on the big screen out front said “98% Wild Slots”.
The sign told the public that the hotel’s slot machines pay out 98% of the money they take in, reducing the “house edge” to 2%. In comparison, the typical slot machine has a return on investment percentage in the range of 85% to 97%.
There were two ways to translate this “98% wild slots” message:
1) This is the best payout percentage available
2) It’s a 2% loser.
I raise this dichotomy now because the evolution of the stock market and the influence of current events cause some people to seek shelter with their investments.
The classic and proverbial “risk-free investment” is the 10-year US Treasury note, which currently yields around 2.15%, although this may change quickly in response to the Federal Reserve’s current actions on interest rates. .
The problem with a return to this level is that inflation is now at its highest level in 40 years. It reached 7.5% in February, measured before the start of the war in Ukraine, which means that it is even higher now.
As a result, there are now two ways to look at classic “risk-free” investing:
1) Making a guaranteed 2% is better than risking a loss in a stock market that has fallen more than 10% this year.
2) It’s a loser of 5% or more, after inflation.
Both of these statements are correct, which is precisely why today’s headlines and market conditions are giving investors a refresher course on risk and how to analyze it.
Things may seem riskier now, but the truth is that risk is everywhere. You can’t avoid one type of risk without accepting another, and the current conditions mean that nothing is comfortable.
The Bloomberg 60/40 Index – designed to show the results of a classic mix of 60% stocks and 40% bonds – has been hammered this year, largely because there is no of ports protected in this storm.
Of course, many experts think the 60-40 allocation stopped working years ago, but that’s just one more reason for investors to weigh the risk in building an allocation. assets.
No matter which dark cloud you fear the most right now, there is no way to quell your fears.
If losing money in the market is your biggest fear and you go all cash in response, your greenbacks are losing purchasing power due to inflation. Meanwhile, if you bet on stocks, there’s no denying that the market could go down from here and stay lower for a while.
The way to reduce the risks associated with these fears is through diversification, and even if that’s not comfortable – investing all your money in what gives you the most confidence and what “feels” you best – it’s necessary. in times like these.
Here’s a refresher on the risks you’re balancing now:
Market risk or principal risk is the potential for the stock and bond markets to kick you in the teeth, and that’s the big bugaboo for most investors.
There is cause for concern here with the market already in correction territory and interest rate hikes likely to drive bond prices down, so the key is finding the right level of exposure, relative to other risk factors.
Inflation or purchasing power risk is in full bloom right now, spookier than at any time in the past four decades.
For most people, it is the “risk of avoiding risk”, when a portfolio becomes too conservative and cannot keep pace with inflation.
Interest rate risk is also in the forefront at the moment. It’s hard to lock in a bank’s or bond’s yield when rates rise because you may find tomorrow that your assets are locked in at what has become a below-average rate of return.
Income risk may relate to personal income levels – available jobs seem plentiful, but salary levels are not rising particularly rapidly – or the possibility that an income stream may decrease in response to rate changes.
Liquidity risk affects everything from junk bonds to foreign stocks to cryptocurrencies. Anyone who invested in the Russian markets a month ago clearly understands this; global liquidity problems are likely to be more common until the end of the war in Ukraine.
Political risk is the perspective that major government policy decisions touch home and affect your finances. These are policies ranging from economic sanctions against Russia, to future social security security, to health care affordability, and more. Given current events, this seems more real than ever right now.
Societal risk is an ultra-wide picture, stuff of world events. War is the greatest of these great events and we have one. What happens next could reshape global markets for the rest of our lives.
All of these factors combine to increase srisk of falling, the possibility that you do not have enough money to achieve your goals; it’s about you more than the market, which means you mainly fight it by saving/investing more.
You might also face return sequence risk — the possibility of you retiring when the market booms, which would reduce the adequacy of your nest egg for life — or special situation risk, about situations in life that have to be paid for, no matter what happens in the rest of the world.
It’s a lot of risk, and practically all of these factors have never been more important than they are today.
Diversification involves addressing each of these risks, ensuring that no one worry can overwhelm you. It’s about protecting against the downsides rather than maximizing the upsides.
So if you’re trying to figure out where it’s best to invest now or next, think about how your biggest concerns might unfold and whether you’ve balanced the associated risks.
If the risks are keeping you up at night, you haven’t dealt with them properly.
Plan your strategy so you can relax whatever the conditions; it’s a big win under these conditions, no matter what the market offers next.