What is the Risk of Investing? It’s Simple!
There is a great disconnect between how different sides of the investment world perceive investing risk. Financial advisors and the clients they serve frequently view risk from a completely different standpoint.
There’s no such thing as a risk-free investment — there is no escape from that. As such, risk is an essential part of any conversation about investments.
Investments do have varying degrees of risk. Some of them are more important to consider than others, and some are easier to mitigate than others.
There is a general risk-reward relationship in which investments with a greater potential return tend to have greater risk. For example, stock investments are generally considered to have potential for greater long-term gain than bond investments. But they’re also riskier.
If you ask a financial advisor what risk is, you may get a clear answer. But you also might not.
Those in the industry are burdened with knowledge of many types of risks and often go on abstract tangents about volatility and standard deviations from normally expected returns and probabilistic outcomes associated with timeframes for which an investment might be held.
That may be an accurate explanation, but it’s completely useless to many investors. While it is valuable information, the client has no idea what the advisor is talking about.
The advisor is trapped in knowledge that becomes an impediment to clear communication.
The investor, meanwhile, wants to know one thing about the risk of the investment — only one thing: What are the chances that I’ll lose money? That’s what risk means to the investor.
Sure, a financial advisor can find some client who wants to know about the probabilistic modelling and how your various volatilities map out across time. But most clients neither need nor want to understand that.
The Financial Industry Regulatory Agency (FINRA) has a great definition of risk on its website: “In short, risk is the possibility that a negative financial outcome that matters to you might occur.” Wow. Simple and clear. Jargon-free. Financial advisors take note: this is how your clients would like you to speak to them. In clear, understandable terms.
This is not to say that financial advisors should either dumb down their presentations or fail to properly disclose risks. The point is that the disconnect is real. Clients don’t understand their financial advisors. When they fail to follow their advisor’s suggestions, it may have nothing to do with the advice itself and everything to do with how it’s presented.
Advice that goes unfollowed has no value.
It moves no one closer to their goals and it doesn’t improve anyone’s finances.
As investors, we can demand something more of our advisors: We can insist on clear, jargon-free explanations that are still sufficiently detailed for us to make decisions. As investors, we can educate ourselves about the risks associated with our investments as sufficiently as we feel is necessary. That way, we know what the chances are that we might lose money. That’s the risk that matters.