Much has been written about “risk” as it relates to investing. This includes something called “risk tolerance,” a quality or trait that all investors possess and that all wealth advisors are tasked with measuring, on a scale from “low” to “high.”
A client’s ability to tolerate risk should influence what an advisor suggests be included in a portfolio, as well as an optimal balance of high-/low-risk investments overall.
But focusing on investors’ risk tolerance in this way portrays risk as some sort of “uncontrollable force” that exists on its own and that some investors have a stomach for, and others do not.
The truth is, however, that if you have an asset, you have risk. If you have a business, you have risk. And if you have a business that advises high net worth investors about risk, as we do, you have risk.
Keep in mind that when the market tumbles, we share that pain with our clients. So, yes, everything has risk, but the good news is, you don’t have to treat yours like something totally out of your control. You can learn to manage it.
The first thing to do is understand your risk and be proactive about managing it. Do this by carefully and holistically assessing and identifying risk points, those areas with the highest vulnerability, whether in your company or your portfolio.
Most people would rather not think about the negative “what ifs” of their investments. Yet, to manage risk effectively, you need to consider all scenarios.
For example, let’s say you are a solar panel manufacturer. At the moment, a growing number of people are signing up for solar power, sales are good, you’re keeping pace with demand and you even have plans for expansion. So, where is your risk?
Well, what if the market implodes for one of the materials you need—copper, for example? The price spikes; shortages occur. But if you had assessed your risk and knew this could happen, you would have managed that risk by hedging copper prices and stockpiling your most vulnerable material when it was at its lowest cost. Not to mention, you would have secured agreements that put you at the head of the line with your suppliers.
You can hedge and manage risk correlated to nearly every business, whether it be your own realty business, where you hedge your risk on interest rates, or if you are the CEO of a private corporation and have accumulated $2 million in corporate stock. In the latter case, you would be in a prime position to assess the risk—or reward—of holding that stock or managing your risk with a quiet sell-off.
The truth is, most people would rather not think about the negative “what ifs” of their business or investments. Yet, to manage risk effectively, you need to consider all scenarios; and that is where your advisor comes in. Assigning you a risk tolerance score is a good beginning, but giving you the tools and incentive to assess your risk is essential to managing it. That includes your investment risks.
Begin with the fact that you cannot get to zero risk with your portfolio, nor should you want to. That’s putting money under the mattress. At our firm, we use the term “risk of chaos,” asking, what is the probability that chaos is going to happen in the market and that there might be a 10 percent drop in the next three months?
We do this every week, working off of scenarios and probability. That is how we manage risk for ourselves—remember, we feel your pain—and for our clients. Putting it in its simplest terms, our feeling is:
If we manage the downside, the upside will take care of itself.
Investing involves risk. Investment return and principal value of an investment will fluctuate, and an investor’s shares, when redeemed, may be worth more or less than their original cost. Advisory Services offered through Strategic Financial Group, LLC (dba SFGI, LLC in Illinois), a Registered Investment Advisor.
This article was originally published in the August/September 2016 issue of Worth.