Playing Through the Risks

Financial Perspectives

“There are no secrets to success. It is the result of preparation, hard work, and learning from failure.”
– Colin Powell

 

Managing a Variety of Risks

By Dennis Wolfe, CPA, CFP & Evan Russell

In the popular film “Field of Dreams,” there is a scene that illustrates the presence of risk. A rookie comes to bat for the first time in a major league baseball game. Overconfident, he winks at the pitcher, who responds by throwing a ball that nearly hits the rookie in the head. He steps out to get a breath before getting back in. The pitcher throws another high-and-tight pitch that is even closer to hitting him. The manager, Shoeless Joe Jackson, then calls time and walks over to the frightened batter. The wise mentor explains that the pitcher did not want to hit the batter but only wanted to make him uncomfortable. He advises the kid to look for a “low-and-away” pitch, but as the rookie turns back to the batter’s box Shoeless Joe adds, “But watch out for a fastball in your ear.” With a man on third, he hits a “low-and-away” pitch to right field to score the run. The rookie experienced the importance of recognizing and playing through risks and was not prevented from having success.

The past few years have presented a range of investment risks; some of which are familiar, while others have been less common in recent times. The Federal Reserve has undertaken measures to tackle inflation, and as a result, bond prices, which have traditionally been viewed as a secure investment option, have declined significantly. Moreover, the ongoing conflict in Ukraine and the shifting dynamics of the global economy, which cast doubt on the supremacy of the U.S. dollar, have further complicated the investment environment. Consequently, navigating investment risks has become more challenging due to the intricate interplay of these factors. Here, we will explore how investors can more effectively distinguish between mere possibility and actual probability and “play through” these and other risks.

Managing Risks

While growth, safety, and liquidity are universally desired goals in investing, achieving an ideal balance can be challenging. Dr. Thomas Sowell, a prominent economist, argues that risks are an inherent part of decision making. He suggests that there are no solutions, only trade-offs involving competing alternatives with different costs and benefits. Individuals must decide which risks are worth taking based on various factor including the nature of the risk, potential benefits, and available resources.

Returning to our “Field of Dreams” analogy, the rookie must consider whether to focus on the less common high-and-tight pitch or the more frequent low-and-away pitch. The answer, according to Dr. Sowell’s perspective, is to pay attention to both. In either case, he might suggest wearing a helmet as a precautionary measure.

 

Here are three of the most common types of investment risk that investors should be aware of:

  • Market Risk – The risk of losses due to changes in market conditions, such as fluctuations in stock prices or interest rates;
  • Inflation Risk – The risk of a loss in purchasing power due to a sustained increase in the general level of prices in an economy.
  • Liquidity Risk – The risk of not being able to sell an investment quickly enough to meet financial obligations.

 

In addition to inherent investment risks, there can also be behavioral reasons why people have trouble processing risks. Here are a few examples:

  • Familiarity Bias – People may prefer familiar risks (e.g., starting a business) over unfamiliar risks (e.g., investing broadly in financial markets).

  • Perception Bias – People may perceive financial markets as riskier than they truly are, influenced by media coverage and past experiences, even though the actual level of risk may be lower than risks encountered in other aspects of life.

  • Control Bias – People may feel more in control with certain risks than with risks over which they have less personal control.

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A good recent example of perception bias that affects investor confidence relates to widespread concerns that the United States will lose its reserve currency status. In a recent edition of Weekly Economics, Raymond James chief economist Dr. Eugenio Alemán cautioned not to bet against the U.S. dollar when he concluded the following:

“We do not believe that a manipulated, non-convertible Chinese currency can compete with the U.S. dollar. This is not because the U.S. currency is perfect, but simply because, at least for now, the U.S. dollar is still the top dog in a weak pack … As of today, the currency is still used in most transactions worldwide. While these numbers have changed over the last two decades, the dominance of the U.S. dollar has remained relatively stable, and it will take a long time for this to change if it ever does.”

While there are uncertainties ahead regarding inflation control, national debt, and the possibility of a recession, it is important to acknowledge that decision making can be influenced by diverse resources beyond mere facts. Nevertheless, by being aware of biases and employing sound financial planning, investors can maintain confidence regardless of what news sources they follow.

Although it’s not feasible to eliminate all risks, investors can effectively manage and minimize many of those risks by understanding and applying practical principles while “playing through.” Time-tested disciplines like asset allocation, diversification, and avoiding detrimental biases can help investors more confidently pursue their goals. In other words, while they may not always hit a home run, they can still achieve sustained success through consistent base hits.

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Securities offered through Raymond James Financial Services, Inc. member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Round Table Advisors is not a registered broker/ dealer and is independent of Raymond James Financial Services. Any opinions are those of Round Table Advisors and not necessarily those of Raymond James. This information is intended to be educational and is not tailored to the investment needs of any specific investor. The information contained in herein does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Holding investments for the long term does not insure a profitable outcome. Keep in mind that there is no assurance that any strategy will ultimately be successful or profitable nor protect against a loss. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification. Past performance is not indicative of future results.

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evan russell

Evan Russell is the newest financial advisor with Round Table Advisors. He holds Series 7 and 66 licenses. Russell recently graduated with a finance degree from the University of Tennessee where he also enjoyed a successful baseball career with the Volunteers.

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dennis wolfe

Dennis Wolfe is a managing partner with Round Table Advisors and senior financial advisor with Raymond James Financial Services. He holds Series 7, 9, 10, and 66 licenses, as well as the CFP® and CPA professional designations.

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