Perspective on risk

By Morningstar |  03-11-20 | 

Risk is something we all encounter. And constantly speak about. But there is much more to it than meets the eye. Here is an assemblage of sorts on risk perspectives.

Risk management is like an insurance policy. - Rupal Bhansali

You can't suddenly think of buying fire insurance when the house is already burned down. Attempt to identify proactively all the risks that you could get exposed to. And if they are overwhelming and large, walk away.

All gambles do not pay off. - Allison Schrager

You increase your odds of a more successful outcome if you can define and articulate your goal. So to embark on the least risky path, you need to identify your goal. Because then you will be able to take risks once you have a clear idea of what you are taking them for.

Which mistake can I lease afford to make? - Mohamed El-Erian

That is the most pertinent question that each individual investor has to ask, and honestly answer. NOT, what will go well for me? BUT, which mistakes can I not afford to make?

In this uncertain world, no one can predict the likelihood of mistakes. No one wants to make a mistake. But the likelihood of making a mistake has gone up.

Most mistakes are recoverable. We discovered that in 2008. So, the question is, which mistake can I not afford to make?

That's a question that every investor should be asking themselves when they look at their asset allocation. And it speaks to their tolerance for risk, their tolerance for volatility and also, what is the time span they think of in terms of their investments.

Risk is what you don't see. - Morgan Housel

The biggest economic risk is what no one is talking about, because if no one’s talking about it, no one’s prepared for it, and if no one’s prepared for it, its damage will be amplified when it arrives.

In recent years, the risks people talked about included trade wars, next quarter’s earnings, budget deficit forecasts, and the elections. It’s not that those things are not risky. It’s that we see them coming, we talk about them, and we can prepare for them. The risk no one was talking about or paying attention to was the global coronavirus pandemic.

So how do you deal with this as an investor?

Think about risk the way California thinks about earthquakes. If you live in California, you know there are going to be big earthquakes in the future but you don’t know when or where. Nevertheless, you have an expectation. You are always prepared for it.

It’s also important to give yourself a wide berth, with room for error, and to realize there’s a distinct difference between getting rich and staying rich.

Getting rich requires swinging for the fences, taking a risk, being optimistic. Staying rich requires a form of pessimism, being pessimistic about the short run, and the ability to survive whatever might happen, whatever may come your way.

What are the risks we are not talking about today?

Something I think people are discounting and are not thinking about enough, and this is not my baseline forecast, are the odds of the economy doing extremely well next year.

What if a vaccine arrives early in 2021 and everyone is soon vaccinated? Life can return to normal. That will release lots of pent-up demand.

Combine that with three things: pent-up demand, savings, and unprecedented fiscal and monetary stimulus.

  • The amount of Federal Reserve stimulus flooding throughout the economy
  • The amount of stimulus from Congress just in terms of stimulus payments that have been made this year
  • The amount of savings Americans have generated this year.

If those two things collide at once, 2021 could be one of the best years from the economy that we have seen in our lives. The counterargument, of course, is that if we don’t get good vaccine news and stimulus measures are fumbled, 2021 could be one of the worst years for the economy in decades.

Both of those extremes seem almost equally likely right now. But I think we are discounting particularly the optimistic side, when things are as bad as they have been in 2020, when you have 40 million people lose their jobs, it seems ridiculous to say we could be facing one of the best economies that we have ever seen in a matter of months.

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