Lately I’ve been thinking about risk in areas other than investing. Last week while visiting Yellowstone for the first time, I found myself calculating: “How close should I get to that wild buffalo I’m trying to photograph?” and “What are the odds that the geyser we are approaching might go off? (It did, and we were DRENCHED), and “Why are those families allowing their toddlers so close to the wild elk standing in the river?” and “Should that woman really be out of her car video recording a herd of buffalo crossing the road right in front of my car?”
Later, I had an interesting conversation with a saleswoman in Jackson Hole about the folly we observed. She called it “the Disneyland Syndrome” meaning some tourists are just certain there is a ride operator nearby who can punch a button to stop impending doom. (Maybe our culture is so used to being rescued on so many fronts that this is more common than in the past….I’ll save that for another day.)
In a typical lifetime career, most people take on various levels of risk. They apply for jobs, learn new skills, make career changes, continue education, start businesses, and hire employees. These risks are part of doing business and successful individuals and businesses are rewarded for risks taken. Of course, there is a chance of failure in some or all of the above. But there is little reward without taking some risk.
In sports or outdoor activities such as skiing, risk necessary for success and the “rush” some are seeking. Those who challenge themselves usually excel more than those on the sidelines playing it safe. Those who take on too much risk suffer injuries or worse.
There are risks in every relationship, but most people are more than willing for the expected rewards of loving, close relationships and friendships. Risk is a part of life – the degree varies by both what we can control (endogenous risk factors) and what we cannot (exogenous risk factors).
When it comes to investments, people tend to evaluate risk differently. For one thing, if you ask someone how much investment risk they are willing to take when the market and economy happens to be thriving, most will say they are quite willing to take on risk for the reward of a higher return. When the market is volatile or on a downward spiral, very likely that same person will change their view and become less willing to accept risk.
Investors who understand that adequate and appropriate investment risk should not be emotionally based, but rather methodical and strategic, are able to view risk with both short and long-term mindsets. Good financial planners need to help a client approach risk differently than riding the investment rollercoaster extremes of greed vs. fear. After years of seeing the upside of risk and then sudden downturns in the early 2000’s, many cannot stomach downturns because they took on inappropriate risks in the past. Unfortunately many brokers are untrained in the world of risk and confuse risk with speculation, leaving out the factor of time, as if all of us would remain young with unlimited recovery time.
The lessons from the last decade have led some to read or re-read the 1830 “Prudent Man Rule,” which elegantly says “to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.” My belief is that combining ethical free market capitalism with the prudent rule mindset and understanding the purpose of investment risk, would allow most to experience less investment volatility and more to have confidence. Our financial markets would require less costly, cumbersome government regulation.
Financial planners should spend time with clients clarifying the amount and type of risk needed to meet personal short and long-term goals. They should explain how it is possible to minimize or smooth out some risk over the long-term. Clients should understand how investment risk is different from speculation or forecasting and particularly get rich quick methodologies Comprehensive financial planners use many variables including: time, stage of life, immediate, near and future needs, proper asset allocation, planned increases in assets (savings), estimated decrease these assets (retirement draw downs), and of course a client’s change in lifestyle. Some risks can be minimized, some can be avoided, and some risk is there for the purpose of long-term growth/reward.
It is important that my clients understand why we are recommending each investment. This allows them to relax and not react daily to market movements. When we review and rebalance, they know why. We don’t jump in and out of investments because each is serving a purpose, and it has been proven time and again that this doesn’t benefit the net worth of a portfolio. We carefully and methodically invest for their personal plan. With investment risk properly defined and assets allocated accordingly, they should experience less volatility than most of their neighbors and friends, and understand each investment’s function within their portfolio.
Not only does this allow clients the sleep they need and the energy to focus on other matters in life, our planner/client relationship invites open communication because we are both have the same goals: THEIRS.