Tuesday, January 15, 2013

Which is More Risky? Owning or Not Owning Stocks? ... MANAGING the Unavoidable Elements of Risk and Reward in Our Financial Affairs

Risk is a four letter word. We live with risk all the time.

To steal a phrase from Shakespeare, "To own stocks, or not to own stocks, that is the question." Sorry about that, William, but it seemed like the thing to do at the time.

Risk is with us everywhere and at all times. It's unavoidable. It simply IS.

We risk eating too much or too little, going to college or taking a job instead, working too hard or not hard enough, exercising too much or too little, getting married or staying single, going deep into debt or foregoing that dream house we can't afford, and so forth.

Risk is. It's up to us to manage it.

Thus, since we can't avoid taking risks and be assured of certain outcomes, the trick is always related to how well we manage the inevitable risks in our lives. Pursuing an education, establishing the habit of savings, investing and taking care of our financial needs, both early on and later in life, are all part of the equation.

How many times have I heard that investing in stocks is too risky and that buying a house with a big mortgage is a safe approach. And it's so untrue.

Stock Investing Isn't the Only Risk in Your Life is very much worth reading and then reflecting carefully on what it says:

"Often when we think of risk, we’re only focused on the risk of investing in the stock market. We think, “Oh, the stock market is risky, and it’s a little scary to buy risky things.”

I can’t tell you how many conversations I’ve had with friends — particularly when they get a little older — that are only focused on this one risk. “I don’t want to own stocks because, boy, that’s risky.”

I remember a conversation I had with a friend of mine who lives in a small town. She was telling me how worried she was about the stock market going up and down. Now, keep in mind, she had very little of her money in the stock market. But she had some money in stocks, as is appropriate for somebody who could expect to live for another 15 or more years.

Here’s the interesting part. When she finished telling me about her stock market worries, she told me she was also very worried about how the price of everything seemed to be getting more and more expensive each year.

This gets us to the big point. When you make a decision to avoid one type of risk, you might be exposing yourself to another one.

In this case, my friend was very concerned about the risk of holding stocks. But she overlooked the risk that comes with holding too little in stocks — which can help her keep up with inflation.

It’s going to cost you more to buy the same loaf of bread in 20 years. Just look at prices 30 years ago, when a loaf of bread cost $0.53, and a gallon of gas was $1.36.

I remember when I was a kid, 30 years or so ago, riding my bike down to the gas station and putting a quarter in the soda machine to get a bottle of Fanta Red Cream Soda. Today, if my kids wanted to ride down to the gas station to get a soda, it would cost them at least a dollar. (Bikes are also a lot more expensive than they used to be.)

The point is that we shouldn’t be thinking in terms of avoiding risk. It can’t be done. Instead, we should be considering which risks we’re willing to take on.

The reality of investing is about making these tradeoffs. It’s about raising your hand and saying, “I’m O.K. with taking on this risk over here, in order to get rid of that one over there.” That’s essentially what the market is —- a place to trade risk and reward.

Back to my friend in the small town. (She isn’t unique. I seem to have this same conversation about risk with lots of people.) When I heard her concerns, I told her a story that always seems to help. If you have a well-designed investment portfolio that’s tied to your goals, you’ve already made decisions and tradeoffs about the risks you’re willing to take. We’re better off in the long run sticking with those plans, because once you start looking for a no-risk investing solution, you’ll likely to veer off into some shady, perhaps fraudulent, investment schemes.

So next time you’re nervous about the risk you’re taking with your investments, remind yourself which risks you’ve actually gotten rid of because of those decisions."

Summing Up

We can't avoid risk in our lives. Risk is.

So while risk can't be avoided, it can and should be managed in a thoughtful and intelligent manner by each of us.

While there are no guarantees, of course, there are some things which almost always certainly will prove to be worthwhile pursuits over a lifetime.

Such things as pursuing knowledge continuously after getting a good formal education, working to achieve and maintain good health, building and maintaining strong personal relationships, saving enough money from what we earn and then investing those savings well to at least offset the effects of inflation are all worthy objectives for a life well lived.

And so is managing the level of debt we take on over time. That's because debt service requirements minimize our ability to achieve savings and invest those savings for our future needs.

Stated simply, from student loans to home mortgages, individual debt levels need to be managed just like any other risk.

To repeat, risk is.

Thanks. Bob.


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