How are you defining it?
by Steve SelengutMr. Selengut is a private investor and a contributing editor to Advisor e-newsLink. He is the author of the book ‘The Brainwashing of the American Investor: The book that Wall Street does not want you to read.’ He can be reached at firstname.lastname@example.org
Most investors incorrectly think of “risk” as the possibility that the market value of a financial asset might fall below the amount that he or she has invested in the asset. OMG, how could this be happening.
These basic misconceptions (that lower market price = loss or bad; higher market price = profit or good) are the greatest risk creators of all. They invariably cause inappropriate actions by individuals who are uninitiated in the ways of the investment gods — i.e., most individual investors.
Risk is the reality of financial assets and markets: the current value of all securities will change, from “real” property through time-restrained futures speculations. Anything “marketable” is subject to change in market value. It is as the gods intended. Portfolios can be designed so that it doesn’t matter quite as much as you’ve been brainwashed into believing.
What is abnormal is the hype surrounding market value changes and the hysteria such hype causes among investors. No way should a weak real estate market translate into near zero bank balance sheet entries — it just doesn’t compute, except when it is popular politics.
Similarly, the reality of financial-impact cycles (market, interest rate, economy, industry, etc.) doesn’t fit at all well into hindsightful, but popular, calendar year assessment mechanisms. Yes, brainwashing again.
Change is inevitable
The amount, cause, frequency, range, and duration of market value change will always vary in an “I-don’t-care-who-you-listen-to” unpredictably certain way — the certainty being that the change in market values of investment assets is inevitable, unpredictable, and (actually) essential to long term investment success.
Without these natural changes, there would be no hope of gain, no chance of buying low and selling higher. No risk, no profits, and no excitement— boring.
The first steps in risk minimization are cerebral, and demand an understanding of the fundamental economic purpose of the two basic classes of investment securities.
From the 401k investor’s perspective: (a) equity securities are expected to produce growth in the form of realized capital gains, and (b) income securities are expected to produce dividend, interest, rent, and royalty income. But nothing produces “real” growth until either the gains or the income are realized — even the incredibly complex IRC appreciates the distinction.
What’s an alternative?
Alternative investments? These are contracts, gimmicks, commodities, and hedges that college textbooks used to call speculations. Once upon a time, fiduciaries, trustees, and unsophisticated individuals weren’t allowed to use them. The stigma was erased by Modern Portfolio Theory, but the real risk has multiplied.
They are especially risky for 401(k) and IRA investors who are unable to differentiate between stocks and bonds from any perspective. Most investors have no clue what is being done inside the products they select, and have little interest in finding out. They even think of these plans as “pension” programs — so do most politicians, which is even scarier.
Wall Street knows this, and takes advantage of it mercilessly. In spite of the recent financial crisis, public sector pension plan fiduciaries are falling all over themselves to throw money at the very “alternatives” that crashed the markets just a few years ago.
401(k) participants are force fed products from self-serving providers who make little effort to identify risk, much less minimize it. Few plans encourage participants to develop an understanding of their speculative choices and even fewer provide pension quality selection opportunities.