Risk Management and the Investor’s Journey

Bad road conditions often produce wrecks; but not always. With the exception of chronic worriers, most of us don’t ponder on the bad things that could have happened yet didn’t. But that kind of thinking is precisely what risk management is all about. It’s not exciting but it is critical.

Each weekday many of us get in our cars and head to work, driving a little slower (hopefully!) when the road conditions are poor, keeping an watchful eye on the cars around us. Fortunately we leave our homes and arrive to our destination with no dented bumpers or accident reports!

No news story would have been printed about how we each made it safely to the office, risking life and limb to reach our jobs. Good risk management often leads to no news and thus no news story. You will never wake up to read an article in this or any other paper proclaiming, “You lived!” This is a critical point in managing risk – whether in life or investment portfolios.

When you opt not to take a specific action rarely do you know how the action would have turned out. That is one reason why risk management is often forgotten.  It gets no credit! Your spouse may be proud you stayed home, but others are frustrated when schools are delayed and cancelled. After all, there were no wrecks! Risk management is critical and its role in saving lives and nest eggs is often overlooked.

There are four – and only four – things you can do with risk. We could have avoided the risk all together and simply stayed home. We could choose not to make an investment or not to jump out of a perfectly good airplane! You don’t know with certainty what would have happened in either scenario.

The trip to the office often takes less than an hour and so we often just head out the door, trusting our driving skills and good luck to get us there. You could leave all of your money in a stock that is fundamentally broken but still going up in price. Until the stock crumbles or the car wrecks, who cares?

There are other routes we could have taken to reach our destination.  We could’ve driven slower to reduce the risk but would not have eliminated it. Diversification in a portfolio is a good example of this mindset. As long as the market is climbing higher and the roads are dry, going slower or diversifying can seem silly!

Last but not least we could transfer the risk if someone were crazy enough to guarantee the trip’s safety. Transferring risk means passing the risk to another – usually an insurance company. Regardless of your choice or risk management style, if nothing bad happens there are no stories, no excitement and no credit to good common sense. But this doesn’t mean we should dismiss managing risk all together, as the market’s recent activity as shown – trends can change rather quickly just as road conditions can worsen in a matter of moments!

 

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see our Disclosure page for the full disclaimer.