Many saving for retirement or any long term financial goal consider risk a real four letter word right now. More specifically equity risk is to be avoided at all cost. We all want to avoid pain. The last decade has been more volatile than usual. Or has it?
Risk and the chance of experiencing negative returns in a portfolio of equities is a very real likelihood. In fact, the longer you hold your portfolio, the more likely you are to experience some years of negative returns. But holding longer also increases the probability that your compound annual returns will be positive.
I don’t know if the next 20% move will be UP or DOWN. What I do know is the next 100% move will be up.
When we invest for the long term we must accept risk. If we try to avoid equity risk, it is replaced with inflation risk or purchasing power risk.
Remember the real return of any investment whether it is equities, bonds, annuities, CDs, money market funds is the total return minus the rate of inflation.
For example, with a money market return of 0.2% minus inflation rate of 3.5% equals a negative return of -3.3%. This means that every year you hold your money in money market funds your purchasing power decreases 3.3%. Compounding returns work in reverse as well.
To keep pace with inflation you need to be invested in equities. We must learn to live with the risk, we must remain disciplined and do not allow the Wall Street bullies to make us trade and speculate with our money.
There are ways to control the amount of risk you carry in your portfolio. Younger investors will likely take on higher levels of risk during the accumulation phase. While retirees might be more comfortable with reduced risk during the spending phase.
Regardless, it is important to understand the risk you are carrying. You should understand the best-case scenario and the worst-case scenario. The equity markets are random and unpredictable. There will be periods when the equity markets are down. Sometimes dramatically, like 2008.
If you understand the amount of risk in your portfolio. You will not allow short term volatility to cloud your judgement. You will not panic during the inevitable down markets.
You will understand that great returns are the result of discipline and understanding.
This is a process that requires the assistance of a fiduciary adviser/investor coach.
We must own equities…..globally diversify…..rebalance.