Risk is NOT a 4-Letter Word

My father-in-law retired from the practice of medicine a few years ago. During his fifty-year career, not only did he establish himself as a highly skilled and dedicated physician, he also displayed a head for numbers as they relate to investments. And because he was smart enough to enlist the aid of a savvy financial advisor, to plan for the future and nurture his investment portfolio, him and his wife are now enjoying a financially stress free retirement, living a comfortable existence courtesy of dividends and interest generated mostly from stocks and a sprinkling of bonds.

That said, not everyone shares his tolerance for investment risk taking. In this regard, one of his colleagues (let’s call him Dr. Aversion), was more inclined to place his discretionary cash in a bank savings account, earning a sometimes decent, sometimes woeful rate of return. Regardless the amount of interest earned, Dr. Aversion gained comfort from watching his bank balance grow, and he slept well at night knowing his money was not subject to stock market whims and fancies.

Now, keep in mind here that, save for a brief stint in California early in his career, my father-in-law lived and worked in Canada. And in this northern nation, the vast majority of medical docs are civil servants owing to the publicly funded health care system. While they are certainly paid well enough to afford a comfortable lifestyle, the pay is nowhere near the lavish sums heaped upon some State side physicians.

Dr. Aversion too was a Canuck based doc. One who didn’t understand the role that investments would play during his retirement. Who didn’t get that a pile of cash sitting in a savings account generating relatively meagre interest would dwindle once he retired, once his primary revenue stream (i.e., salary) came to an end.

Today, predictably, Dr. Aversion is paying the price for his unwillingness to become educated about investments and the role of risk, for clinging to the illusion of safety represented by cash. A few years after retiring in his early seventies, reality gave the good doctor a cold, bare handed slap. And he sold his luxury home and downsized to more modest accommodations because he needed to raise cash for living expenses.

Now near the age of 80, Dr. Aversion is doing his best to hold steady on the financial front, having finally enlisted the guidance of a financial expert. And though he is not likely to slip into poverty, he certainly will not return to his once financially stress free lifestyle. Though he was a fine physician, Dr. Aversion was an inept steward of his family’s money.

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You Want Success? Embrace Risk

In the investment world, ‘risk’ refers to the probability of losing part or all of your investment. Risk is not, as way too many people view it, the same as volatility. And it’s volatility that turns investors into scaredy-cats. And scaredy-cats make terrible, horrible, no-good investment decisions that most often turn into losses.

You see, volatility is part and parcel of the stock market. It’s simply the stock markets nature, ingrained in its DNA. If you understand this, then you accept the ups and downs and wild rides. Because you are confident that, based on more than 100 years of stock market performance, if you hang on for long enough, the stock market will smile upon you.

Check out the chart below published by Investors Friend:

total-real-26-2016Unlike other assets, stocks go through severe ups and downs from time to time. And investors with a long term horizon know this. They know that media noise heralding the end of the financial world as we know it (think 2007-2009 meltdown), is just that: noise, distraction, media publishing their usual ‘the sky is falling’ nonsense because it makes for good copy, believing readers want to be fed fear.

But if investors can muster the will to stomach the occasional precipitous fall in their portfolio value, they will be rewarded. When? No one can say for certain. Still, I’ll venture out on a limb here and say … it’s only a matter of time.

Let’s use the 2007-2009 meltdown as an example. Global markets dropped what, 40% or so? And for those who ingested a daily dose of Gravol to help calm nerves and restrain the fear impulse from hitting the sell button? Well, these folks reaped juicy rewards.

Check out the chart below (which is current only to 2015; sorry folks, a bit outdated. Given the continued market climb from 2015 through 2017, you can safely add on an even higher return than that shown by the chart):

150825113628-market-good-bad-since-recession-780x439

So, we’re talking more than a doubling or tripling of your money if you invested in 2009. And the way to have made this happen if you’re not the type to buy individual stocks but still wanted exposure to stock markets? Buy passive index Exchange Traded Funds (ETF).

How do you get a piece of the 30 blue chip companies comprising the Dow Jones? Buy an ETF such as the SPDR Dow Jones Industrial Average ETF (NYSEMKT:DIA).

Prefer to focus in on the technology sector? Buy Fidelity Nasdaq Composite Index ETF (ONEQ).

More comfortable investing in the broader market? Consider the Vanguard S&P 500 Index ETF (VFV). With each of these ETFs, your fortune is tied not to one individual company stock, but to all of the companies that make up the stock markets.

With each of these ETFs, your fortune is tied not to one individual company stock, but to all of the companies that make up the stock markets. (chewy bit: I do not own any of these ETFs, and am not recommending them one way or another. However, I do recommend you use these ETFs as a starting point for your research).

 

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Time Is On Your Side … Until It’s Not

On the issue of investing, Dr. Aversion was paralyzed by fear. And while fear led him to grow his cash stash, it wasn’t enough to last him for 20 or 30+ years of living post-retirement. Because today, you’re actually losing money by holding funds in a savings account, i.e., the rate of inflation is higher than interest paid so, in effect, these funds are worth less at the end of each year.

What would have happened if Dr. Aversion had a better understanding of stock markets, was willing to embrace at least some risk during the past 50 years? Most likely, he would not have downsized his home, nor would he be worried about outliving his money.

The huge, colossal, gargantuan, mistake that folks make is paying attention to stock market daily gyrations underpinned by self-serving political and media generated fear.

If we can block this out, if we can educate our self about the true nature of the stock market leading to a clear understanding of what it is we’re doing when investing, if we accept that volatility does not equal risk, and that we should have at least a three, five, ten, twenty or more year investing horizon, then we’ll be just fine.

And with patience as our ally, we’ll get to that place where our money is working for us, a place that affords us a financially stress free retirement not unlike that currently enjoyed by my father-in-law.