Risk and return – these are the basic concepts in the investing realm. In order to achieve a greater return, the investor must be willing to take on greater risk. We ask clients about their tolerance for risk, their ability to withstand the volatility and negative events that will come at some point. This is a tough one for any of us to answer or describe. No one wants to take undue risk with their hard-earned money, yet there is a fear of missing out on opportunities for gain. It is important to understand as much as possible about the risks involved in investing, as, interestingly, understanding and being respectful of the risks creates a less risky scenario.
Howard Marks, the Chairman of Oaktree Capital Management LP, just this week put out a memo entitled Risk Revisited. This is a detailed and interesting examination of risk that challenges some basic beliefs and reinforces others. A couple of the takeaways:
- A widespread belief that “there is no risk” is the riskiest scenario. When investors forget about risk and think there are only upside outcomes, peril awaits. Remember when real estate could never go down in value? That tech stocks would only increase in value? Being risk conscious, performing extensive due diligence, being conservative in outlook and clear on the probability of outcomes is the better alternative.
- The time to be conscious of risk is always. Given today’s low interest rate environment on the lower risk asset classes, we see money flowing into the more aggressive asset classes as investors look for return wherever they can find it. As prudent investors, we need to be even more so now as others leave caution behind. As Marks points out, we “move forward, but with caution,” emphasizing the caution side of the equation.
- While we need to clearly examine the risks and control them to the extent possible, it is neither possible nor prudent to avoid all risk. Marks makes clear that “risk avoidance usually goes hand-in-hand with return avoidance. While you shouldn’t expect to make money just for bearing risk, you also shouldn’t expect to make money without bearing risk.”
The study of risk reinforces that we cannot take all of the risk out of the equation. Outcomes are not predictable and the future is not knowable. We move forward with caution and with care.