Volatility Isn't Risk And Temporary Decline Isn't Permanent Loss
I was talking to someone the other day and they asked what I did for a living. I said I'm a financial advisor and I specialize in retirement income and investment planning for electric cooperative retirees. Simply put, I help my clients make a plan to not run out of money in retirement.
Then they asked me about the current "market" and how "risky" things are right now. That got me thinking. It seems there are many people who can't distinguish between risk and volatility. Are you one of them?
It seems there are many people who can't distinguish between risk and volatility. Volatility isn't risk. They aren't the same thing at all.
What is risk?
Risk - A situation involving exposure to danger. Pertaining to investing, I define risk as the chance of permanently losing your money.
What is volatility?
Volatility - The liability for something to change rapidly and unpredictably. As it pertains to investing, I define risk as the unpredictable up or down movement of a stock price.
How should you define volatility when investing?
Volatility - The up and down movement of company (stock) prices around an increasing trendline over time.
The illustration below which shows volatility but no risk.
Why does this matter?
We have well over a century of history showing that the real long term return of large company stocks (S&P 500) is 7%. Over that same 100 years we have seen that the real long term return of comparable bonds has been 3%.
Yet people will look me straight in the eye and tell me bonds or annuities are "safe" and less "risky" than large company stocks aka the best companies in the United States and the world.
Is that a true statement?
If risk is a situation exposing me to danger then it would stand to reason that investing long-term in the greatest companies in the world is not risky at all.
If volatility is the liability for something change rapidly and unpredictably in the short term then it also stands to reason that investing long-term in the greatest companies can be volatile at times.
What is money?
At 80/20 Financial Services we define money, by it's only sane definition which is purchasing power. Your money/purchasing power loses a fraction of its value every single day because of inflation. Inflation increases on average 2-3% per year which means our money/purchasing power loses 2-3% per year. I'll save you the math but that means every 20 years your money/purchasing power is cut in half.
If you have all your money in "safe" investments throughout a 20-30 year retirement, without realizing it, you have crafted a plan to run out of money/purchasing power at some point. It's literally inevitable.
An individual can have financial security on the front end of their remaining lifetime meaning right here right now. You can put all of your money in bonds and the money you have will barely fluctuate at all. You'll get a little income from that and you'll sleep like a baby because you're not taking on any risk.
But one day, in about 20 years, you'll run out of money. You'll run out of purchasing power and that, my friends, is the real risk in retirement.
But one day, in about 20 years, you'll run out of money. You'll run out of purchasing power and that, my friends, is the real risk in retirement.
You have a choice
You could choose to take some insecurity at the beginning of retirement by investing in large company stocks. You will experience volatility, but remember volatility is the up and down movement of prices around an increasing trendline over time. That's not risk.
Remember: Volatility isn't risk and temporary decline isn't permanent loss
You need a plan
A goal of retiring - without a plan - is simply a plan to run out of money. At 80/20 Financial Services our specialty is retirement planning for electric cooperative retirees.
A R&S Pension is not a retirement plan.
A 401k is not a retirement plan.
Those are just pieces to the retirement plan puzzle.
We help our clients create retirement plans!
Contact us for any general questions.
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80/20 Financial Services is an Independent Registered Investment Advisory Firm. We help Electric Cooperative Employees create their retirement income and investment plans.
Photo by Carl Edwards with The Behavior Gap
