A Measure of Risk

There are two ways to measure how well you are doing in your investment account:  In percentages or in dollars.  Which feels worse: “I am down 5%” or “I am down $50,000”? For a $1,000,000 portfolio those are one and the same, but it is much more frequent that I hear down moves described in dollar terms because it feels like actual money lost.  That focus makes sense.  Percentages don’t pay the bills, dollars do.

Investor focus on dollars gained or lost brings up two very important behavioral issues:

  • All performance measures look backwards, which has limited value in making decisions about the future.
  • Measuring performance in a way that feels more painful (dollars) means investors run the risk of making emotional decisions.

What if we were able to measure our investing progress in a healthy way that helps us to make good decisions along the way? It would mean looking at more than what just happened in the markets.  We would have to take into account a topic that is harder to quantify: Risk.  In the past, investors were asked about their tolerance for risk by checking Conservative or Aggressive, or on a scale of 1-10.  The problem has been that these questions get answers that are often gut feelings and rooted in a bias toward recent events. It’s hard not to feel a little more bullish when the markets are racing ahead!

There is now a better way to quantify risk and have a positive impact on our behavior.  We use a financial technology tool called Riskalyze that has been developed to help frame our tolerance for risk in a unique way.  Here is how it works:

  • Investors complete a questionnaire based on how much they have invested, and how much they can stand to gain or lose (in dollars) over the next six months.
  • They are then asked if they are willing to trade a little more protection for the sake of higher returns.
  • By the end of the questionnaire, that willingness to trade safety for return generates a unique Risk Score on a scale of 1-100. That score will indicate a range of acceptable returns, both positive and negative over a six-month time period.
  • The investor’s portfolio is then given a score based on the risk and return profile of every stock, bond, or fund that they own.

At the end of the exercise, an investor can assess whether there is alignment between their tolerance for risk and the way they are actually invested.  Someone with a Risk Score of 30 might be surprised to know that they are invested like a 70.  The goal is to make sure we manage situations where fear or greed could emerge. If we understand what our investments could lose or gain in the short-term, we will be less likely to chase after higher returns or flee for safety at the wrong times.

Riskalyze does three things that help support better outcomes for investors.  It creates greater self-awareness by asking questions based on the numbers that matter.  Everyone’s definition of being conservative or aggressive is different and this helps to focus on how each person identifies with risk. Riskalyze also helps us to understand if an investor’s expectations and their investments are aligned.  We will never know what will happen in the future, but if we understand what could happen it will keep us from overreacting. Finally, it helps us as planners to go back to the financial plan and model the returns and risks that a client needs to take to reach their goals.

If you would like to see how it works for yourself, click here (Riskalyze) to complete the questionnaire and learn your Risk Score.

Disclosure:  Riskalyze, Inc. is a third-party unaffiliated technology company. The information presented is for general purposes only and is not meant to be construed as investment advice. This material includes the proprietary information of Riskalyze and is not warranted to be complete or accurate. Except as otherwise provided by law, neither Morton Brown nor Riskalyze shall not be responsible for any damages or losses resulting from the use of this information. For a full evaluation to determine which investments may be appropriate for you, contact Morton Brown Family Wealth, LLC, a Registered Investment Advisor with the U.S. Securities and Exchange Commission.


June Market Note- Managing Expectations

In the last month, stock markets around the world have been adjusting expectations.  Expectations about the future are important because often it is not a matter of economies being good or bad that drives shares higher. Of greater concern is whether the economy is getting better or worse.  The U.S. economy growing at 2% instead of 3% is still growth, just at a slower pace.  That expectation of a slower pace is what drove May’s sell-off.  The global economy is growing, but more slowly if trade negotiations lead to higher tariffs and Brexit continues its rudderless course.

Adjusting expectations lower has meant stock market declines, but that has also created a flight to safety.  Bond yields have dropped steeply in recent months, which means that investors have been rewarded for keeping high quality bonds as ballast.  The low returns that we saw on fixed income through the first few months of the year felt reassuring as bonds rallied into the stock sell-off.  Here were the monthly total returns on some of the major indices:

S&P 500: -5.65%

MSCI All Country World Index: -5.92%

Barclays US Aggregate Bond Index: 1.75%

It is always a valid question to ask whether a bad week, of month, or quarter should call into question the way that you are invested.  In reality, the good businesses that you invest in have to operate every day in an uncertain environment as existed in May.  Howard Marks, in his book Mastering the Market Cycle, describes how businesses have to face unpredictable conditions much like a hitter in a baseball game.  A Hall of Fame hitter with a .300 lifetime average still failed to get a base hit 7 out of ten times to the plate.  A hitter of that caliber was capable of greatness in every at-bat, but forces out of his control were also at play.  Here are some of the factors that hurt a hitter’s consistency, according to Marks:  His health, the weather, stadium lights, the crowd, the game situation, the quality of pitches, his guess of the next pitch, his diet that morning, his bed time the night before.  In a vacuum he might hit a home run every trip to the plate, but no at-bat ever takes place in a vacuum.

We are watching trade negotiations and interest rates very closely, but they too are operating in a complex environment with many factors at play.  If trade issues were magically resolved tomorrow, we would still wonder how that affects the Federal Reserve, for example.  Every diversified portfolio is designed to weather multiple events and developments.  Our job as investors is to not become so consumed with one story that we lose our appreciation for complex economies.

Here some interesting pieces related to expectations that caught our attention in the last month:

Uber and the expectations of an IPO

Inflation has been dormant, but are our expectations too low?

Churchill: Walking with Destiny.  My recent book project…Managing the expectations of a nation at war when nothing is certain.