Occasionally, and always when things are going well, a client will ask us for a riskier portfolio, which usually means we are supposed to sell those good-for-nothing bonds and add more stocks. In other words, “risk up.”
Our industry has done a disservice to investors by oft-repeating this phrase: “The more risk you take, the more return you’ll earn.” Sometimes this is flipped, as in: “To obtain a high return, you must take more risk.” After years of this mantra, we can’t blame investors for reacting to good returns by wanting more “risk”. And note that these sentences are constructed to appeal to every human’s inclination towards greed: who wouldn’t want more return?
The problem is, these shorthand phrases are akin to incomplete sentences. Technically they qualify as complete sentences, but in fact they leave off the most important concept around risk, the thing about risk that will make you cry, feel despair, and swear off stocks forever and this time I mean it: risk means big losses as well as big returns.
On your way to earning 90%, your risky portfolio will hand you months, even years, of misery. That’s “will”, not “may” or “might”. You will have losses. If you put $100,000 into an S&P index fund on 1/1/08, it was worth $63,000 by the end of that year. It took until sometime last year to get back to even – nearly four years underwater. Furthermore, if you react by selling because you just can’t stand it any longer, you will effectively decimate your returns for years to come. The lack of money in your portfolio will only reinforce your misery.
On the other hand, if you truly have the temperament for it, a risky portfolio will eventually hand you more return than non risky portfolio. Eventually.
Here is how to know if you are a candidate for a riskier portfolio than you have now, assuming you’re not already way out in the risk stratosphere:
- When stocks go down a lot, you get excited. You can prove this because in 2008/9, you added to your stock portfolio and/or you did not stop your 401(k) contributions to stock funds.
- On the other hand, when stocks go up a lot, you worry.
- You think about your portfolio as a whole, and losses on this or that individual holding do not bother you. You do not obsess about making back losses.
- You are willing to increase your investment time horizon. In other words, if you were investing for the next ten years, you can take on more risk if you recognize that you must think now in terms of investing for the next fifteen years. You may need those extra years to recover from losses.
- You inherited a bunch of money/invented something really cool/found oil in your back yard and do not need to live off your portfolio any longer.
- When the news about the economy/politics/environment is bad, you understand that this, too, shall pass. You can insulate your investment decisions from how you feel about the news.
If the majority of these things are not true of you and your investment behavior, better think long and hard about “risking up”. Even if you can identify with most of these descriptions, be careful: timing counts. With stocks bumping up near highs, now may not be the best time to increase portfolio risk.