The investment world is constantly changing thanks to advances in technology, big data, information transparency, the global economy and ever-fluctuating trends in consumer sentiment and populist politics. While investment risks may run rampant these days, it’s important to remember that risk is personal. To help guide your investment decisions, you should assess and prioritize what risks you are willing to take and where you draw the line.
Overview
Risk is relative. What may seem risky to one person may not be a big deal to another. Or perhaps it is a big deal, but worth it. For example, one investor may be reluctant to invest in high-risk stocks because he or she is nearing retirement, while another may not have enough wealth accumulated by that point and is willing to take on greater risk for more growth opportunity.
Risk can be quantitative or subjective, like the risk that a company doesn’t have the fundamentals to warrant its high stock price and yet its products sold like hotcakes during the holiday season.
Yesterday’s Risks
In today’s bold, brash new world there are more risks than ever. But first, let’s start with a review of some of the more traditional investment risks:
Market risk — The risk of losing money due to market declines.
Valuation risk — The risk that a stock’s price may not reflect — or be priced above — its true value based on underlying fundamentals.
Inflation risk — The risk that an investor is not invested aggressively enough to outpace the impact of long-term inflation.
Allocation risk — The risk of putting too many eggs in one basket. Diversifying investments across a variety of asset classes may help keep portfolio performance level during periods of market volatility.
Today’s Risks
Over the past 10 years, new risks have come to the forefront. For example:
Social Security risk — With large numbers of the baby boom population retiring each day, the nation’s safety net program continues to be under pressure. The latest projections estimate trust fund assets will provide for the program’s current benefit levels for only 17 more years.¹
Global economy risks — Now that we have a more inclusive global economy, what happens in one country can have a ripple effect that impacts others.
Longevity risk — People who live to a ripe old age, which is more common these days, have a higher risk of running out of money during retirement.
Unknown risks — With longer lifespans come more unknown risks, such as the risk of needing significantly more assets to pay for unexpected medical expenses and/or long-term care during retirement.
Sequence of return risk — If an investor’s portfolio suffers from market declines early in retirement, he or she has less time to make up the losses and may run out of money sooner than if the decline happens during a later stage of retirement.²
Sequence of Return Risk
As detailed in the table below, both investors withdraw the same amount of income over the same time period from portfolios that provide the same average annual return. However, the investor whose portfolio experiences poor performance in the first few years of retirement ends up with significantly less in assets.³
These examples are hypothetical only, and do not represent the actual performance of any particular investments. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and when sold or redeemed, you may receive more or less than originally invested.
Tomorow’s Risks
As we enter 2017, we face rising interest rates, burgeoning inflation and the uncertainty of an incoming president and cabinet with little political or government experience. Investors and their advisors should carefully consider the new potential risks that could impact portfolio performance.
Interest Rate Risk
After a decade of near-zero interest rates, they finally appear to be on an upward trend. In December, the Federal Reserve increased its benchmark rate by a quarter point to a range of 0.5 to 0.75 percent, with guidance projecting three more rate hikes in 2017.⁴ In the fixed income market, rising interest rates will introduce new bonds with higher yields causing the price of existing bonds with lower yields to drop. While conservative investors who rely on individual bond income may feel the pain, those who hold bond funds will benefit from a gradual trading up to newer, higher-yielding bonds without the loss of principal.⁵
Global Trade Risk
Campaign promises for renegotiated trade agreements pose the risk of higher tariffs for corporations and higher prices for consumers.
Productivity Risk
President-elect Trump has emphasized a focus on new jobs emanating from increased domestic manufacturing and infrastructure spending. However, America’s demographics could have an impact on how quickly companies are able to expand and create jobs:
With large numbers of baby boomers retiring every day, the American workforce continues to shrink.
Should offshore jobs move back to the U.S., they likely will be dominated by new technology, requiring job candidates to have a higher level of education. Recent numbers of unemployed and under-employed college-educated young adults could exacerbate the current trend of unqualified candidates, impacting future labor quality.
The inability to find qualified candidates could hurt both company growth and expansion and create a drag on wage growth and consumer spending.⁶
A decline in legal immigration may further exacerbate the ability of U.S. companies to recruit the skills necessary to fill IT jobs.⁷
Political Risk
Normally, we associate political risk with more volatile countries where there is civil unrest. However, amid controversial campaign rhetoric, lack of practical governing skills and a worrying assortment of potentially conflicting business interests, the new incoming U.S. president poses more political risks than the usual change in administration. Recent analysis revealed that more than 100 Trump companies have conducted business in 18 countries and territories across South America, Asia and the Middle East.⁸ On one hand, this international business experience could provide the incoming president with unprecedented skill in foreign affairs. On the other hand, it’s just a matter of waiting to see what happens.
New World, New Risks …
“In the modern world of investments, market risk is only one element of all the risks that currently exist. Just over the past few years, risk has evolved past some previously held preconceptions.”9
Final Thoughts
As you can see, investors face various types of investment risks. And yet, we continue to take calculated risks that lead us to successes, failures and, more likely than not, mixed results. The most any of us can do is establish specific financial goals for our investments, pin them to a timeline and monitor their progress, and identify our individual tolerance for each type of risk in the new world.
¹ Social Security Administration. August 2016. “Fast Facts & Figures about Social Security, 2016.” https://www.ssa.gov/policy/docs/chartbooks/fast_facts/2016/fast_facts16.pdf. Accessed Dec. 14, 2016.
² FMG, LLC. Oct. 5, 2015. “Sequence of Returns Matter in the Real World.” http://www.paulried.com/blog/sequence-of-returns-matter-in-the-real-world. Accessed Dec. 14, 2016.
³ Ibid.
⁴ Martin Crutsinger. Time. Dec. 14, 2016. “The Federal Reserve Has Raised Interest Rates for the First Time in a Year.” http://time.com/4602535/federal-reserve-interest-rate-hike/. Accessed Dec. 14, 2016.
⁵ Jeff Brown. Money. Nov. 30, 2016. “How to Invest in Bonds as Interest Rates Rise.” http://money.usnews.com/investing/articles/2016-11-30/how-to-invest-in-bond s-as-interest-rates-rise. Accessed Dec. 14, 2016.
⁶ John Fernald. Federal Reserve Bank of San Francisco. Oct. 11, 2016. “What Is the New Normal for U.S. Growth?” http://www.frbsf.org/economic-research/publications/economic-letter/2016/o ctober/new-normal-for-gdp-growth/. Accessed Nov. 16, 2016.
⁷ Issie Lapowsky. Wired. Nov. 23, 2016. “Trump’s Immigration Crackdown Could Spark a Tech Brain Drain.” https://www.wired.com/2016/11/trumps-immigration-crackdow n-spark-tech-brain-drain/. Accessed Dec. 14, 2016.
⁸ Drew Harwell and Anu Narayanswamy. The Washington Post. Nov. 20, 2016. “A scramble to assess the dangers of President-elect Donald Trump’s global business empire.” https://www.washingtonpost.com/business/economy/a-scramble-to-assess-th e-dangers-of-president-elects-global-business-empire/2016/11/20/1bbdc2a2-ad 18-11e6-a31b-4b6397e625d0_story.html?utm_term=.7936b9d75e6b. Accessed Dec. 14, 2016.
⁹ Aberdeen Asset Management. Aug. 12, 2015. “Risk in the New World.” http://www.aberdeen-asia.com/en/thinkingaloudus/culture-and-inspiration/ris k-in-the-new-world. Accessed Dec. 14, 2016.