How Do You Measure Investment Risk?

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There are a lot of sophisticated measures in the investment business: P/E Ratios, Cash Flow Analysis, EBITDA, etc. The list goes on and on (and on). The one I find most interesting, however, is how most people measure risk. The generally agreed upon method is to measure volatility, which is how much the price of a particular asset (stock, bond, whatever) goes up and down, often in conjunction with looking at expected return of the particular asset. To simplify it a bit, the more the price of something changes, the riskier it is.

I find that fascinating and mostly wrong. If you are a long-term investor armed with self-control, measuring risk by measuring volatility is not very useful. This analogy is a bit of a stretch, but I’ll use temperature as an example. If a particular day starts at 60 degrees Fahrenheit and goes up to 80 then back down to 60, that would be considered “worse weather” than a day that starts at 100 degrees and stays there (or 40 degrees and stays there).

Now, if you are an investor who is actively trading, constantly moving in and out of different positions, volatility is important. Likewise, if you are an investor that is going to need to take money out of a particular investment in the near future, volatility could be important. But I prefer a different measure of risk: how likely are you to meet your goals?

To me, this is really the only measure of risk that matters. Will your investment portfolio/strategy achieve the goals you have set for it? If you are a long-term investor (and if you end up working with me you will be :-), you don’t care all that much about the daily ups and downs of your investment, as long as at the “end” your investment is up a sufficient amount that allows you to achieve your goal. Which means that if you construct your portfolio correctly, there is really only one sub-component of that risk that matters: you.

More specifically, do you have the self-control, the discipline, to follow your investment plan? When bad things happen (like the Great Recession in 2008, or the dot-com bubble in the early 2000’s, and the value of your investments drop, sometimes by a lot), will you be able to stay the course and not bail on your plans? One of the main reasons to hire a real financial planner (or even avail yourself of my services), is that they hopefully will help you to stick to the plan. While there are no guarantees, based on the entire history and theory of financial markets, if you invest for the long-term and don’t sabotage yourself by abandoning your investment plan at the worst possible times, you are (almost) guaranteed to be successful.

In fact, there is plenty of research that most investors earn less (often far less) than the mutual funds and other investments they invest in earn. How can that be? They buy high and sell low. They typically buy into a mutual fund (or stock, or whatever) after if has performed really well for a while (missing out on most of the gain), then lose heart and sell when it inevitably goes down. It’s the investor’s behavior that causes them to under-perform, and hence the riskiest part of investing isn’t typically what you choose to invest in, it’s you.

So what’s the secret?

  1. Spend less than you make.
  2. Regularly invest the difference in low-cost index funds.
  3. Don’t sell (unless you’ve achieved your long-term goal).

I’ll write several more posts exploring different aspects of this, but it pretty much is that simple. That’s one of the most frustrating aspects when I hear others talk about their finances. Either they are too afraid of “investing” because they are worried about losing their money (or somebody taking advantage of them), or they are constantly moving from investment to investment to try to outperform the market (generally with poor results, as that study indicated).

As I mentioned in one of the FAQs, about 90% of what you need to do is really pretty straightforward, and not all that hard to do, if you simply know a little bit and have that self-discipline. I’d be happy to get you started on that path.

Photo credit: Foter.com

Who Should Use Fisch Financial?

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Let me be clear, many of you should not. Many of you should hire a full-blown certified financial planner (CFP) who uses a fee-only method (as opposed to percentage of assets managed). This is especially true if you have a more complicated situation such as owning multiple real estate properties, or being part of a trust, or having a complicated legal situation (among others).

So if the above is true (and it is), why am I offering this service at all? Well, three main reasons.

    1. The majority of Colorado educators (my “target audience” if you will) do not have complicated situations. They have one or two incomes, have a mortgage on a house, have normal bills and maybe have some investments, but they aren’t very knowledgeable (or at least not confident in their knowledge) of how to handle their finances (and often just aren’t very interested in the topic). While they would also benefit from seeing a “real” financial planner, there are a lot of relatively straightforward changes they should probably make that I can help them think through. Which leads to reason #2…
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    2. A lot of you won’t hire a certified financial planner (at least not yet). A lot of folks are intimidated by financial stuff, and they are worried that someone will lose them money or, worse, actually take advantage of them for financial gain. These folks are typically not that confident in their own knowledge and are worried they won’t be able to work intelligently with a financial planner and therefore will “waste” the money they pay the financial planner for no real gain. While I think any good financial planner can add a lot of value, it doesn’t matter if you won’t hire them. By offering a free service, I hope to not only help you make some positive changes in your finances, but perhaps also get you to the place where your confident enough to work with a certified financial planner should you choose to.
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    3. I want to help. That maybe sound cheesy, or cliche, but it’s true. I’ve been interested in financial topics since high school when I worked in a credit union, and have continued to read a lot and learn over the years. I’ve certainly made many mistakes (and undoubtedly am still making some now, although hopefully not too many), but I feel like I’ve learned a ton over the years and am in a position to help others avoid any mistakes they might make (or possibly correct mistakes they’ve already made). For a lot of people, there are somewhere between 3 and 10 relatively simple things they can do that can make a huge difference in their financial security (and, therefore, in achieving their goals in life). I can help you figure out those things.

In addition to the general financial/investment knowledge I bring to the table, I’m very knowledgeable about one aspect that is key for Colorado educators: PERA. While most Colorado educators have a vague idea that PERA is a good thing, they don’t realize how good, and they also don’t realize that having PERA should affect all of their other financial decisions, and not just when they are close to retirement, but from day one that they start in PERA-covered employment.

This (along with lack of understanding of benefits and specifically 401k/403b/457 plans) is one of the main reasons I decided to offer my services. Over the years I’ve had so many conversations with very bright educators who nevertheless have very little knowledge of these areas and consequently have made decisions that have not been optimal. This may or may not be you. For some of you, working with me will end up making very little difference because you are knowledgeable and have made good decisions along the way. But it won’t cost you anything (other than a little bit of time) and it should reassure you that you’re on the right path. For others, this truly could be life changing. And I don’t say that lightly, being financially secure really can change your life and allow you to focus on what really matters – financial success isn’t the goal, it’s the means to achieve whatever your goals are.

Photo credit: Mark Dumont via Foter.com / CC BY-NC