Investors have all gotten extremely complacent about investment returns as the market has churned higher and higher. The most recent stock market pullback is a small taste of what could be a very small part of a much larger bear market.
Risk is not something to be ignored but rather embraced so you can make rational decisions about your investments. The financial world has many ways to talk about risk—alpha, beta, Sharpe ratio and so on—but at the end of the day, how much do you, or frankly most financial professionals, really understand about these terms? The answer is: not much.
No one really understands risk, so investors don’t talk about it and the consequences are significant. Only one in four clients say their financial advisor has talked about how much their investments may decline if the market crashes, per an investor survey by FinMason, a financial technology firm.
We like to think our team is different and we constantly talk about the risk factors in the market using tools like our recent resource report on maximum drawdown.
We Need To Talk… About Risk.
There is no good reason to avoid discussions about risk. Unless you support “CHEAP” passive investments in which case you should avoid the risk discussion like the plague!
People think about risk and reward trade-offs nearly every day, most often outside of the context of the investment markets.
Consider these choices:
- “Should I buy life insurance?” You weigh the risk of paying too much premium for a life policy, versus the reward of knowing your beneficiaries get some degree of financial protection.
- “What should my car insurance deductible be?” You may reward yourself with lower premiums by choosing a higher deductible, but you risk paying more out of pocket if you have an accident.
- “Should I go to the gym or stay on my couch?” You risk the poor health consequences of a sedentary lifestyle for the reward of easy entertainment.
We think all the sophisticated ways to measure and discuss investment risk make the discussion more complicated. It needs to be kept simple. The one risk measurement you should care about the most (whether you realize it or not) is maximum drawdown risk—how much can you potentially lose in a catastrophic market downturn?