03/21/2025
You Don’t Understand Risk
Written by Geoffrey Schaefer, CFP®
Often I hear from clients and potential clients,
“I’m worried the stock market will go down.”
“Don’t stocks have a lot of risks?”
“Can’t we lose all of our money in stocks?”
Most of this is gleaned from the news media which actually contains much information while holding little truth. News is sensational. It is filled with data points and polarizing facts, often without context. Truth is steady, truth can be repetitive, truth will not garner clocks and thus impossible to find in the news media.
When we listen to the news rather than truth, we get scared of what we hear and then project that fear onto every part of our life.
Let’s talk investments for a bit. You’ve heard from the news that the president is going to tariff this, or this company’s sales are dropping, or the economy is tanking… yada yada yada. There is always something for the news to broadcast here. So, we hear that and we say, wow, this is too risky! We have to do something! Right?!?
No.
Let’s define risk.
In the financial context it is the possibly of complete loss. You have a home and it burns down. You have a car and it is totaled. You have a stock and that company goes out of business. The loss is complete and irreparable.
In the case of a home or car, we all have insurance policies to help cover this risk. In the case of an investment, what do we do?
I’d like to now introduce another term, often thrown around negatively, but actually it is more likely to be seen in a positive context: volatility.
Volatility is the chance of sudden and unpredictable movement. Nick Murray defines volatility as the price movement, both up and down, along a long-term trend line.
When it comes to investing, we often mistake risk for volatility. You have a portfolio of diversified stocks worth $500,000. Over three months, the value drops to $400,000. You’ve lost $100,000, right? Wrong!!
You’ve only lost that value if you sold the investment after the drop in value (which by the way, that is exactly what human nature will lead you do and you shouldn’t.)
That drop was likely not a result of risk, rather than volatility. The same volatility that pushed it upward every month prior to that, but only noticed when it moved in the opposite (negative) direction.
Here is some negative volatility that the largest 500 stocks in the U.S. have experienced in my lifetime:
- The dotcom bubble of 2000. The market dropped nearly 40% over three years.
- The great financial crisis of 2008. The market dropped 37% in one year.
- Covid 19 in 2020. The market dropped over 30% in less than three months (but finished the year up 18%).
- The 2022 market. It doesn’t have a cool nickname, but the market dropped by over 18%.
All of that negative volatility. Seems like a terrible deal, right?
The S&P 500 measured at 326 in September of 1990. It now sits at over 13,224. A total return of over 3,640% which is over 11% per year.
$10,000 put into the stock market in 1990 would be worth $374,290 today. The real risk is not investing at all. The real risk is selling in a Covid-19 market or tech bubble moment rather than staying the course.
When we are not invested, we usually are not doing so because it is “too risky.” We’re doing so because we do not have a financial plan that acts as a roadmap and guidepost when the news gets louder than the truth- and it will.
Are there some examples of investment risks? Yes, here are a few:
- Having 100% of your investments in one company stock. This carries the possibility for massive and even complete loss.
- Following fads like the meme stock mania, cryptocurrencies, foreign currency exchange, aggressive options strategies. None of these are investments, they are speculation at best and deserve little to no room in your overall financial plan.
- Timing the market. By the time a drop occurs, it is too late to get out without incurring losses. Human nature leaves us paralyzed by fear so pulling the trigger on getting back in will be nearly impossible.
- We sell low and buy high. Something goes down and we get out and we put that money into the fund that is doing well. Humans are tragically prone to recency bias. Because something is true of the past 6 months does not indicate it has always been true, or will continue to be true in the future.
- Inflation. Not investing will absolutely subject you to the risk of inflation. In 30 years, your purchasing power will be cut in half and then some. Not investing leaves you subject to a certain and inevitable fate.
Studies show that average investors underperform the market by almost 6% because of the reasons above. Those are real risks that are costing us, as investors, money and peace of mind. Our behavior is sabotaging our portfolios.
Here are more common mistakes investors
How do we get peace of mind with our investments?
Make a financial plan! A financial plan aligns your values with your capital. It clearly defines your goals and will tell you what must be done to get there. As part of a financial plan, you will develop a diversified and sustainable investment portfolio that will ultimately fund your goals and keep you away from the risk of trend following, market timing and hasty decision making.
Invest based on that and then tune out the noise that distracts you. CNN does not care about you, nor does Fox. Your coworkers RobinHood account or a hunch from your uncle will not aid you in achieving your financial goals. Make a plan or find a planner who will help you make one and hold you accountable.
Understand that when investing, risk is different than volatility. Make a plan, identify the risk, and invest! I can’t tell you how many times I hear, “I wish I would have started sooner.”
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