Dictionary.com defines risk as “exposure to the chance of injury or loss; a hazard or dangerous chance.” In investment parlance it means, “I would like to invest to make more money but I don’t want to take a risk.” “I want an investment more rewarding than a bank account but I want it to be safe.” Investment advisors and financial planners are getting more and more statements of that ilk.
Investors are frustrated by a Federal Reserve policy that keeps interest rates near zero. They also remember 2008-2009. They don’t want to do that again. In mid-2008 the SPDR S&P 500 Trust ETF (SPY) hit a high around 150 before plunging to near 70 in early 2009. Recently trading in the mid-to-high180 range, SPY delivered a nice recovery for the patient and stalwart. But memories and risk sensitivities linger, especially for those nearing or in retirement.
Last year’s unexpected but strong numbers in the stock market have increased risk-related questions. “Sure, 2013 was great, but can it last?” Market turmoil in January focusing on emerging market currency concerns and some softness in American corporate profits and economic indicators fanned fears.
Some of the January selling of stocks was tax related. There was a good bit of tax selling at the end of 2012 ahead of the increases in capital gains taxes in 2013 and new Medicare surtaxes. Consequently, stock bought in early January of 2013 did not attain long-term capital gain status until January 2014. Profit taking related to last year’s run-up was deferred into this January. Who said “taxes don’t matter”?
As an advisor with a fiduciary obligation to a client, the word “safe” must be defined. If it means “I don’t want to lose a dime’s worth of principal,” that’s what banks and FDIC guarantees are for. Absolute safety means low returns, a reality unlikely to change near term. But even bank deposits carry risks to future purchasing power if the return is negative adjusted for taxes and inflation.
In the past bonds were a refuge for the risk averse. However, when interest rates rise, bond prices decline in an inverse relationship. The bond world no longer is simple. Risk minimization strategies applied to fixed income are a hot topic. The words “fixed income” are problematic in a world of variable living costs, especially applied to food, fuel, medicines, and medical care, items heavily used by retirees and widows.
The concept of “risk versus reward” should be defined along the lines of an “endowment spending policy.” Figure out what it takes for you to live, basic living with a “fun and freedom” component added. What percentage of your savings bucket or retirement savings will be spent near term, each year, looking forward over the next 3 to 5 years? That amount should be kept in a “paycheck fund,” a safe repository such as a bank money market fund. A risk-adjusted bond strategy could provide a secondary reserve.
A diversified pool of global equities, including dividend paying stocks, could comprise a third “bucket” of money. Dividends could flow into your money market fund.
Advisors can explain uses for alternative investments, strategies common to major endowment funds. These may involve non-liquid positions in real estate, private equity, energy, business development companies, mutual funds that act like hedge funds, and other income generating formats. Certain levels of net worth and income are required by regulators before one can invest. Higher potential returns means higher potential risk; pros and cons must be evaluated.
One way to evaluate risk is to ask, “If I invest X dollars in an investment, and it underperforms or I lost it all, would my standard of living be imperiled?” If the answer is “yes” or if you could not sleep at night, don’t do it!
Relative to stocks, long-term investors should see periods of market softness as opportunity. Warren Buffet opines, “The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces.” If you have reserves to run your day-to-day life, the Buffet strategy for wealth building makes sense!
Lewis Walker is President of Walker Capital Management LLC. and Walker Capital Advisory Services, Inc., a Registered Investment Advisor (R.I.A.) Securities and certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker is a registered representative of SFA which is otherwise unaffiliated with the Walker Capital Companies. ▪ 3930 East Jones Bridge Road ▪ Suite 150 ▪ Peachtree Corners, GA 30092 ▪ 770-441-2603 ▪ email@example.com