moneyFYI
Financial Freedom Is Merely Organized Common Sense
What Do You Think Risk Means
Risk can have two meanings.
- The permanent loss of some or all of the capital and/or income. This is most common with private equity investments and startups. The defence to this situation is the same as my old sensei offered, “The best defence to a dangerous situation is to be somewhere else.” Avoidance is cheaper than repair.
- The volatility effect is the one most commonly implied when discussing investment risk.
People tend to understand permanent loss, but volatility confuses them.
If an investment can earn, on average, 10% per annum, like the S&P 500, but is subject to variances that can be quite large, you could find your investment is down 40% at some point while you hold it. That loss is a paper loss, although it feels real, and unless you must have the money that day, the loss has no meaning for you. You must sell the investment to have a permanent loss.
That leads to an obscure reality.
For stock market investments, the risk is two-part, 1) variability and 2) potentially permanent if you might need the money on an adverse day. The first of these is inevitable, while the second is something you can analyze. How likely would you require the investment, as money, before its intended target date? All of it or just a little?
The defence to variability risk combined with need risk is liquidity. Maintain your maximum expected need in a money market fund or something similar. That deletes the volatility risk.
It does not delete the emotion, though. That’s on you.
I build strategic, fact-based estate and income plans. The plans identify alternate and effective ways to achieve spending and estate distribution goals.
Be in touch at 705-927-4770 or by email at don.shaughnessy@gmail.com.
moneyFYI 