Are Your Investments Too Conservative?

A few years ago, a recently retired client came in and stated, “I need to be very conservative with my investments, I can’t afford to take any risk.” Perhaps you’ve had the same thought during periods of market turmoil. When you avoid the stock market, are you being conservative? Or are you confusing risk with risky?

The word risky describes something that is dangerous or perilous. Robbing a bank is risky. Driving your car 120 mph is risky.

On the other hand, risk is a math concept that concerns probabilities; the likelihood of something happening.  While you can manage risk, you can’t fully eliminate risk because it’s part of everything you do in life.

If your investment portfolio has only a small probability of maintaining purchasing power over the long-term, is that conservative or is it foolhardy? If you are investing for “safety”, but your portfolio fails to outpace inflation, how “safe” is that? If your investments don’t keep up with inflation, your lifestyle suffers. In reality, you can’t “afford” to invest without risk.

Loss of purchasing power over time is just as real as a temporary decline in the value of your portfolio. Following an investment allocation that is too conservative can increase your overall risk of sustaining your lifestyle.

Financial markets can be very volatile at times. Volatility is a built-in component of markets and should be distinguished from risk. If you choose not to invest in the stock market, are you avoiding risk? No, you’re just transferring the risk to some future date. Remember, you’re not investing for today, you’re investing because you will need these funds at some point in the future.

In reality, the volatility of financial markets pales in comparison to the behavioral volatility of many investors. People are more volatile than markets.

As an investor, you expect returns to help compensate for your risk. Returns are created in the first place because there’s always something to worry about. The economy, interest rates, inflation, and on and on.

If you want to be a conservative investor, focus on building a portfolio with reliability over the long term. Then, go about reducing your emotional responses to scary events or worrisome trends. Famed investor/fund manager Peter Lynch said, “The real key to making money in stocks, is not to get scared out of them.” Start there.

Related: Do You Know the Cost of Complexity?