From Wall Street to Main Street

by Robert Norton

Investors Face Many Different Forms of Risk
Webster’s Dictionary defines risk in terms of loss: “Exposure to the chance of injury or loss; a hazard or dangerous chance.” For investors, a more appropriate definition is “uncertainty of expected returns.”
Risk is one of the most avoided, misunderstood, and least quantified subjects by the financial services industry. This is unfortunate because the primary purpose of investment professionals is the intelligent management of financial risk and the alignment of an investor’s risk capacity with the appropriate exposure.
One dimension of risk capacity is investors’ knowledge about it. The more they understand it, the more capacity they have for it. We face risk today because nobody can consistently predict the future.
Investors who try to time the market put themselves at risk of missing exceptional returns. This practice may negatively impact an otherwise sound investment strategy. According to a study by Ibbotson Associates, missing the one best month of each year drastically reduces returns. During the years when returns are negative, the effect of missing the best month exaggerates the loss. Timing the market consistently is very difficult.
How do you rate your knowledge about investing in general, and, more specifically, your understanding of the relationship among risk, return, and time?
All are interconnected. Higher exposure to the right risk factors leads to higher expected returns. Another Ibbotson study shows the rate of returns for large-company stocks (or “large caps”) over one-, five- and 20-year holding periods. On an annual basis since 1926, large cap returns have ranged from a high of +54 percent to a low of -43 percent. The average returns range from +29 percent to -12 percent over five-year periods and from +18 percent to +3 percent over 20-year periods. Even during the worst 20-year holding period, stocks still posted a positive compound annual return.
Following a long-term strategy is easy during good times; the hard part is sticking with it through the bad times. “Investors ultimately reap rewards only if they maintain positions in the face of market woes,” says Yale University Chief Investment Officer David Swenson in his book, “Unconventional Success: A Fundamental Approach to Personal Investment.”
The question is, how much risk should you take within your portfolio? While you need to consider many factors, addressing some of them right now would be prudent. For example, assume your investments do not increase in value. How many years do you have left before you plan to start withdrawing at least 20 percent of all your investments for your expenses or other needs? What is the worst 12-month unrealized percentage loss you would tolerate for your long-term investments?
Market volatility may cause portfolio values to fluctuate both up and down. If the market drops or corrections occur early during your retirement, the portfolio may not be able to cushion the added stress of systematic withdrawals. Your portfolio may not provide the necessary income for the lifestyle desired or may run out of money too soon.
What should you do if you’re a long-term investor sitting in the midst of a bear market? If you are holding a well diversified portfolio, and you address risk, time horizon, expected return, asset class preferences, and taxes, the answer is simple…stay the course.
Robert Norton is the owner of Norton Wealth Management located at 235 Bellevue Ave. For more information call, 704-0444.