Discipline: Managing Risk and Reward
Without risk there can be no reward in financial markets. However, when the S&P 500 Index is down by more than 50% (see chart below) many people tend to reassess their tolerance towards risk. We know, because we have been right there with our clients. It remains and uncomfortable fact that in order to reap the rewards of investing, an investor must be willing to sustain risk.
When severe downturns occur, such as in early March 2009, when the S&P 500 Index® was down by more that 50% since January 2008 (see chart), we provide perspective and information on market events so that investment discipline can be maintained and the payoff for bearing risk can eventually be reaped.
Our job as adviser is to help our clients understand the tradeoff between risk and reward: how much investment risk they should take in order to meet financial objectives. Once we have determined an appropriate level of risk, we allocate the “risk budget” to where it is expected to provide the most return.
In times of severe market turmoil, when the risks, and expected returns, for staying in the market (i.e. when the cost of capital for companies) are the greatest, we help put events into perspective for our clients. Stocks are risky investments (they have fallen significantly in value in the past) and that is why they are expected to offer greater returns over time. Well-crafted and understood investment plans, which may have horizons of 30 years or longer, and which include appropriate reservations for expected liquidity needs, allow for better management of the emotions that we as investors experience when things look the bleakest.
