Risk Reduction

Prudent financial management typically involves the use of risk reductions strategies. Too much risk can destroy hopes and dreams. Most investors are familiar with investment risk. Everyone knows investments in stocks, and other assets can fluctuate. Bond buyers are especially familiar with interest rate risk. With the expectation of rising interest rates long term bonds are viewed by many highly risky. There are two other risks however that the media as well as many investors fail to fully appreciate.

These are inflation risk and investor behavior risk.

Inflation risk is the possibility that your assets could lose value or purchasing power due to the fact that the costs of goods are rising faster than the value of one’s assets. Savers who have their money sitting in the bank making zero to 1 percent have been losing buying power each year because inflation historically has averaged about 3 percent annually. In today’s low interest rate environment bank and money market accounts have been consistently losing buying power.

Investor behavior risk has been the subject of several studies most notably the Dalbar survey. Over the last 30 years for the period ended in 2016, the S&P 500 averaged 10.35 percent, yet the average retail equity mutual fund investor eared only 3.66 percent during that period. The typical investor typically behaves badly when it comes to making smart investment decisions. There may be periods when the stock market increases yet investors lose money due to poor market timing and stock selection. If you are the type of investor that has consistently under-performed the stock market you should probably utilize investment strategies that minimize investor behavior risk. In my opinion, the best strategies are the ones that allow investors to achieve their financial goals with the least risk and the least stress.