How can risk be an opportunity? (excerpt)On the Trading DeskSM—
By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist
When it comes to investing, risk can create opportunity. Find out how as Dr. Brian Jacobsen, CFA, CFP®, interviews Peter Speidel, CFA, investment analyst with Wells Fargo Funds Management, LLC, and Scott Engroff, CIMA®, CFS®, sales manager with Wells Fargo Funds Distributor, LLC, in this excerpt of On the Trading DeskSM from Friday, May 3, 2012.
When we think about the word risk, we often think of the fear of loss. But it's when you put risk into perspective that you can begin to see the opportunities that risks can also bring. So we want to bring you a few programs this year specifically to discuss risk: revising your perspective on risk, refocusing on your goals, and refining your investment strategy to meet your goals.
Let's address the headline question. Peter, in terms of investing, how can risk be an opportunity?
Speidel: Risk and return go hand in hand, and from an investment perspective, it's important to ask yourself, "Am I being rewarded for the risks that I'm taking?" The opportunity is: Can I possibly take on risks or more risk that may offer more return?
And, Scott, for financial advisors and individual investors, how can be risk be an opportunity?
Engroff: Risk is often associated with fear—the fear of losing money. So the opportunity is to question what fears investors have and learning how to alleviate those fears.
Well, let's address these concepts that we laid out at the beginning. First, we're encouraging investors to revise their perspectives on risk. Scott, why do you think investors might want to revise their perspectives on risk?
Engroff: It’s really to help investors alleviate their fears by correcting their misperceptions of risk. What the research has shown is that investors often make decisions based on external influences and tend to react to past experiences. We often make decisions based on emotion rather than rational thinking. And this can cause us to make decisions that aren't aligned with our long-term goals.
Can you offer us an example of how misperceiving risks resulted in people missing out?
Engroff: Yeah—since the market began to recover in March 2009, the S&P 500 Index has been up 23%. The investor who stayed in cash all that time, the price they paid was all the missed opportunity.
In that case, what can an investor do to revise their perspective on risk?
Engroff: First, test your reactions against real data. Question your decisions. Second, stay informed. Broaden your knowledge of investing. Learn what opportunities exist around the world and in other asset classes and in other categories. The best advice I can give is partnering with a financial advisor because you get access to their knowledge.
Peter, we’re talking about refocusing on goals. What's at stake if an investor doesn't?
Speidel: The best way to think of that is with an example. Say you retire at 65. According to the Social Security Administration, you're likely to live another 17.4 years. If you were to withdraw 6% of your portfolio annually, and you're parked in cash because you're afraid of taking investment risks, you would run out of money in less than 17 years. You've just outlived your nest egg. What happens if you live longer? The risk is that when you retire—depending on the size of your nest egg—you may have to make difficult lifestyle decisions. When you refocus on your investment goals, you gain a better understanding of the impact of your investment decisions, and you may discover that it might benefit you to consider taking on additional risk.
That leads into the third concept, which is refining your investment strategy. Scott, what does that mean for an investor and an advisor helping their client?
Engroff: Revising your investment strategy is the plan to meet goals. If you're an individual investor, look at your investments holistically and find ways to refine your approach. Perhaps your employer sponsored plan has investment options that could be weighted better, or you might discover alternative or asset allocation-type investment vehicles. It's also a great opportunity for an advisor to reopen a client's investment policy statement or create one if they don't have one and work together to refine the client's approach with this newly discovered vision of risk.
Peter, on the portfolio management level, I'm assuming that portfolio managers aren't going to change their process or their philosophy on risk, but the market does seem to churn quite a bit, and new risks pop up. What do you think refining an investment strategy means for a portfolio manager?
Speidel: Risk and return go hand in hand, but we also know that risk and price go hand in hand. Ideally, a portfolio management team is looking at risk in terms of the price of risk—that is—which risks are expensive and which risks are cheap. Those cheap risks might represent opportunities. We like to see a professional investor who's taking on risks that are cheap and avoiding risks that are expensive. In our experience, that's not easy for an individual to do. That's why active management is so important.
Gentlemen, that's almost all the time that we have today, but I'd like to offer a parting thought and perhaps a few key takeaways. I think that there are a lot of misperceptions about risk: What is risky and what is not? And this is an opportunity for investors to realign their portfolios for their longer-term goals. That's really why we're trying to encourage people to revise the way that they look at risk, then to refocus on those longer-term goals. And in order to achieve those goals, recognize that every decision you make today with your portfolio, including perhaps sitting in cash, is an investment decision, and it's going to affect your ability to reach those long-term goals. And that's why we want people to refocus on risk. Peter, Scott, thanks for joining us.
Speidel: Thanks, Brian.
Engroff: Thanks for having us.
The views expressed are as of 5-8-13 and are those of Chief Portfolio Strategist Brian Jacobsen; Peter Speidel, CFA; Scott Engroff, CIMA®, CFS®; and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.