Traditional pensions are gradually disappearing from American culture. More and more of us will depend on our own investments to cover some or all of our living expenses during our "golden years." Prospective retirees' goals are pretty straightforward: to enjoy a satisfying retirement and to provide a meaningful inheritance for their families.
That dream seemed secure through the '80s and '90s when U.S. investors were enjoying steady double-digit annual returns from both stocks and bonds! But a strange thing happened on the way to retirement ... the world got a lot more dangerous!
You already know that interest rates have become microscopic; so-called "safe" investments like bank accounts and government bonds pay less than the rate of inflation! And, of course, the value of the home that many of us were counting on as a retirement asset has shrunk. Well then, what about stocks, the supposedly highest-return asset class? We've seen stock values cut in half twice in the last 12 years!
Most people who've been looking forward to a happy and secure retirement weren't anticipating these sorts of disappointments! Fear is rising among would-be retirees.
All of which brings us to the subject of this edition of the Blue Sheets: RISK ... specifically, investment risk as it pertains to retirement income security.
Mr. Webster describes RISK as exposure to the possibility of loss or harm.
Very few people actually enjoy risk. But life has taught us that the companion to every decision we make is the possibility that it will not work out as well as we had hoped.
We decide what school to attend, whom we will marry, where we will live, and what sort of work we will do. All of these decisions involve a risk of disappointment or loss; yet we keep making important decisions because, as Melinda Gates said, "We believe in taking risks because that's how you move things along."
And so it is with investing for our retirements. In this edition of The Blue Sheets we will examine with you the various faces of investment risk, and outline the Financial Advantage discipline for managing these risks to a happy outcome.
Risk Needn't Be Scary
When most investors hear the word "risk" they imagine big declines in the market value of their 401(k) or brokerage account. When your account value shrinks month after month, and you're really not sure why, it's easy to imagine that you are just not lucky or that the deck is stacked in favor of the insiders. And a natural instinct is to want out... to stop the pain.
But, for most retirees, trying to avoid risk by not investing is a terrible decision. It's a decision to give up on your dreams. When you come to understand that all the different kinds of investment risks which we will describe have been irritating investors throughout the history of free market capitalism, you will begin to see that risk is just a reality that needs to be managed.
Farmers learn to cope with dramatic weather changes. Retailers must adjust to radical changes in fashion. Aerospace engineers are continually pushing the frontiers of materials strength. Yet, despite inevitable setbacks, all these professionals keep achieving wonderful successes.
And so it is with investment managers. Our professional challenge is managing perpetual uncertainty. When we make decisions to invest in a company's stock, there is a chance that its leading product might be broadsided by a new invention. If we buy a government bond, we do not expect that country's credit to be suddenly downgraded... but it could. If we invest money in a mutual fund, we are making a commitment to a certain manager's investment style... which could always go out of favor.
In each case we are acting on a particular conviction about the future ... about a company's likely success in its market ... about the growth of consumer spending ... about a nation's currency and its fiscal policy ... about a business sector's growth prospects ... or about the valuation of stocks in general. But the future is always unknown. Always! In a global economy as dynamic and multi-faceted as ours, there will be constant surprises, some good and some not so good.
Because the risk of disappointment is ever-present, we believe long-term investment success requires:
a) Emphasizing highest convictions about the future, derived from continual research
b) Making diversification an unwavering commitment
c) Focusing on fundamental value; not overpaying
d) Being adaptable when the future unfolds differently than expected