Not all risks are equal

Not all risks are equal

Photo credit: M.G.N. – Marcel on VisualHunt / CC BY-NC-ND

‘You take a chance getting up every morning, crossing the street or sticking your face in a fan.’

Police Lt. Frank Drebin, ‘The naked gun’

Many of the people whom we encounter, when asked about their attitude to risk, describe themselves as ‘risk-averse’.  We should hardly be surprised by this when they are considering risk when it comes to investing, as most of us have received little education in how investing works.  When faced with a complex and unfamiliar subject, it is hardly surprising if the reaction is to perceive risk and to take as little of it as possible.

Despite this, even these individuals take risks every day.  Merely to reach our office they have got out of bed, probably walked down some stairs, crossed a street, used a train and or a motor vehicle and travelled in a lift.  Even getting dressed is not without risk – every year, a surprising number of people arrives at Accident and Emergency having managed to injure themselves with their trousers.  Fortunately, most people perceive this risk as insufficiently large to deter us from wearing them.

At some point, they have probably also made some of the important life decisions, such as which degree to pursue, which jobs to apply for (and which offers to accept) and where to live.  In most cases, they have selected someone with whom to share their life and perhaps also decided when to have children and how many of them.  All these decisions are subject to some uncertainty outside their control and where a mistake can have adverse consequences.

While risk is ever-present in life, we can attempt to mitigate it by following, even subconsciously, some process which is designed to eliminate the worst options.  Depending on the decision, we might carefully research the market (although perhaps not when considering a future spouse!), consider the short and long term consequences and trading between our emotional and intellectual responses to end up with something which feels ‘right’.

In some instances, we might engage an independent third party to assist, particularly when dealing with a subject with which we are unfamiliar.  Such a person may be better equipped to assess the potential positive and negative outcomes of any decision by dint of their greater knowledge of that field and will be less distracted by our biases and emotions (although they will inevitably have some of their own).

In the field of investing, a good financial planner will provide this value by converting your particular needs, desires and values into a coherent plan which is designed to help you achieve them over time.  Of course, it is not essential to employ a financial planner or any other sort of adviser before you invest.  Many people do so and a significant number of those are successful at it, at least by the measures that they apply.

Yet investing without professional advice can lead to them taking unnecessary risks.  More importantly, they can be risks which are not rewarded by any compensating return.  Examples include trading individual shares, using past returns to identify what to buy and sell, relying on supposed experts to forecast the future, trading excessively and failing to maintain the level of portfolio risk with which they are comfortable and need to take to achieve their goals.

If they do achieve success in such circumstances, it is likely to be despite their actions rather than because of them; akin to surviving walking across a busy motorway by dodging the traffic rather than using the available footbridge.

In investing, working with risk entails accepting that the market, which is simply a way of reflecting all investors’ views in prices, already does plenty of worrying about the future on your behalf.  Other investors are continually trying to identify the best opportunities (and to avoid the worst ones), so there is no need for you to try to guess what the market will do next.  Instead, you can take the rewards that the market offers and spend your time doing something that you enjoy and which enhances your life.

If you do employ an adviser, what you invest is the time to help them to understand your goals and values so that your plan is specific to you and it can evolve as your circumstances and goals change.  By doing this, you increase the chances of achieving those goals in the timescales that are important to you.

Even with an adviser to help you, you can never remove risk from your portfolio altogether.  Risk and return are related; without risk, there is no return.  However, a good adviser with access to the accumulated understanding of a considerable body of academic research and experience can help you to focus on those risks which have an associated return and thus to improve your chances of a good outcome.  One of the risks without any associated return is that of trying to do everything yourself.