We have been hearing a lot about “risk” the past few years. In fact, it has become another one of those dirty, four-letter words. Something you should shy away from. Something that can hurt you. Something BAD. Having been in this business since 2004 and having seen several bear markets (technically speaking) and one indisputable big bear in 2008-09, I understand firsthand what the term means. I also know that without it, there can be very little reward.
I don’t believe taking risk is, in itself, a good or bad thing. I think the mistake is made in misunderstanding it. An investment is something that gives an investor the opportunity to grow his money over time, sometimes substantially. With that opportunity comes the possibility of loss, sometimes short-term and sometimes long-term or even permanent. This is why we don’t “put all our eggs” in the proverbial basket. However, those investors that understand risk have three things in common:
1. They do not panic
2. They see “One man’s crisis as another man’s opportunity”
3. They recognize the time to take risk is when nobody else wants to
Stocks are risky, right? That is just something that is understood, especially in relation to bonds. But what does that really mean? Is it just as risky to invest in the S&P 500 when it’s trading at 1,100 as it is when it’s trading at 1,400? The answer is ‘no.’ In fact, it’s not mathematically possible for that to be the case. The S&P can still lose value at 1,100, obviously, but it cannot lose as much value as it could from 1,400. The risk has become less. Conversely, the reward of investing in the S&P at 1,400 is much less than at 1,100 – risk and reward have a symbiotic relationship. Without one, we cannot have the other.
Now, every investor has a different risk tolerance: The level of risk with which he or she is comfortable. Part of my job is matching my clients’ respective risk tolerances with what I see in the current market environment on a risk/reward basis. In my view, it is not appropriate to advise a 40-year old married couple to significantly reduce the “risk” in their portfolio when the market corrects by 5- or even 10%. To do so could be ignoring the couple’s long-term objectives, and reducing their potential investment reward. In some cases, in fact, it might make sense to increase the level of risk in their portfolio after such a correction – with the idea that prospective reward has become greater than prospective risk.
Have a great week!
Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067