The Many Faces of Risk
Knowing the different types of investment risk
can help you cope with market volatility.
When was the last time you checked your retirement plan balance? If your balance was less than it was the last time you checked, you probably felt a bit of pain. Everybody does. Where exactly does that pain come from? It’s called risk, and all investments involve some degree of risk. In finance speak, risk refers to the degree of uncertainty and/or potential financial loss inherent in an investment decision. In general, as investment risks rise, investors seek higher returns to compensate themselves for taking such risks.
Every saving and investment product has different risks and returns. Differences include how readily investors can get their money when they need it, how fast their money will grow, and how safe their money will be. Let’s take a look at the many faces of risk we all experience as investors. While it may not take the pain away, it will at least help you cope a little better with market volatility.
Business Risk
With a stock, you are purchasing a piece of ownership in a company. With a bond, you are loaning money to a company. Returns from both of these investments require that the company stays in business. If a company goes bankrupt and its assets are liquidated, common stockholders are the last in line to share in the proceeds. If there are assets, the company’s bondholders will be paid first, then holders of preferred stock. If you are a common stockholder, you get whatever is left, which may be nothing.
One of the advantages of investing in a stock fund (versus a single company’s stock) in your retirement plan is that business risk is mitigated to a certain degree. Because your money is diversified among several companies, the business risk is spread out. The same can be said about investing in a bond fund versus a single bond issuer (in particular a single corporation).
Volatility Risk
This is the type of risk you are likely most familiar with (and the one that you hear about the most in the media each day). Even when companies aren’t in danger of failing, their stock price may fluctuate up or down. Market fluctuations can be unnerving to some investors. A stock’s price can be affected by factors inside the company, such as a faulty product, or by events the company has no control over, such as political or market events. The 2008 financial crisis and the onset of the COVID-19 pandemic in 2020 were prime examples of market events that significantly affected stock prices.
Inflation Risk
Inflation is a general upward movement of prices. Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of interest. The principal concern for individuals investing in cash equivalents is that inflation will erode returns.
Interest Rate Risk
Interest rate changes can affect a bond’s value. If bonds are held to maturity, the investor will receive the face value, plus interest. If sold before maturity, the bond may be worth more or less than the face value. Rising interest rates will make newly issued bonds more appealing to investors because the newer bonds will have a higher rate of interest than older ones. To sell an older bond with a lower interest rate, you might have to sell it at a discount.
Liquidity Risk
This refers to the risk that investors won’t find a market for their securities, potentially preventing them from buying or selling when they want. This can be the case with the more complicated investment products. It may also be the case with products that charge a penalty for early withdrawal or liquidation such as a certificate of deposit (CD).
Big Picture Perspective
January 1, 2001 through December 31, 2020
- S&P 500 delivered an average annual return of 9.06%.
- BONDS delivered an average annual return of 4.88%.
- STABLE ASSETS delivered an average annual return of 1.52%.
- INFLATION has averaged 2.06% a year.
Source: Kmotion Research
Retirement in Motion Retirement in Motion Retirement in Motion
Tips & Resources That Everyone Can Use
Knowledge is Retirement Power
On August 14, 1935, President Franklin Roosevelt signed the Social Security Act. Eight-five years later, Social Security remains one of our country’s most valuable financial resource programs. As of June 2020, over 64 million people (or more than 1 in every 6 U.S. residents) were collecting Social Security benefits. The average monthly retirement benefit is $1,514, or about $18,170 per year. This is just some of the wealth of information you can
read about in “Top Ten Facts about Social Security” published by the Center on Budget and Policy Priorities.
Check it out at: https://www.cbpp.org/research/social-security/top-ten-facts-about-social-security.
Q&A
At what age am I required to start taking distributions from my retirement plan?
Thanks to the Setting Every Community Up for Retirement Enhancement Act (enacted on December 20, 2019), the age at which the Internal Revenue Service requires you to begin taking required minimum distributions (RMDs) was raised from age 70½ to age 72. You must take your first RMD by April 1 of the year after you turn 72. Subsequent RMDs must be taken by December 31 of each year. Note that if you delay your first RMD until April, you’ll have to take two RMDs your first year. The first will still have to be taken by April 1 and the second by December 31.
Quarterly Reminder
It’s that time again — time to change the password to access your retirement plan account (as well as any other accounts you have). Some generally accepted rules of thumb are to change your passwords every 90 days, use different passwords for different accounts, never write them down, and never type passwords on devices or networks that you do not control. To make creating
and managing passwords easier, many people subscribe to password manager services. Check out Consumer Reports for ratings on various service providers, as well as more password tips: https://www.consumerreports.org/digital-security/tips-for-better-passwords/.
Tools & Techniques
Have you increased your retirement plan contribution this year? If not, no worries — there’s still time! After all, it probably only takes 3 minutes by the time you log in to your account and click on the appropriate account management tool. The question is: where are you going to find the money? One easy way to find extra money is to review your homeowners insurance policy. Raising a $500 deductible to $1,000 can cut your annual premium up to 25%, according to the Insurance Information Institute. And, increasing the $250 deductible to $1,000 on your car insurance could save you up to 40%.
Corner on the Market
Registered Investment Advisor
A registered investment advisor (RIA) is a person or firm who advises individuals on investments and manages their portfolios. Some also provide investment consulting services on behalf of an organization’s retirement plan. RIAs have a fiduciary duty to their clients, which means they have a fundamental obligation to provide investment advice that always acts in their clients’ best interests. RIAs are required to register either with the Securities and Exchange Commission or state securities administrators.
Information for this report was provided by CRA’s Investment Advisor, Innovest Portfolio Solutions.
Innovest is a Registered Investment Adviser registered with the US Securities and Exchange Commission. Unless explicitly stated to the contrary, the material herein is not intended to provide and should not be relied on for investment advice. Under no circumstances are we ever providing tax, accounting or legal advice.
Past performance is no guarantee of future results. Investing involves the risk of loss.
This document may contain returns and valuations from outside sources. While the information contained herein is believed to be true and accurate, Innovest assumes no responsibility for the accuracy of these valuations or return methodologies
