Life is a series of risk and reward decisions
The framework of our life will be determined by our daily decisions and the daily disciplines to the achievement of those decisions. The level of risk, or adventure, or achievement – is ours to make, enjoy, celebrate or regret. When deciding on any course of action we have the ability to consider the consequences – this is likely to stem from our cognitive capability. Our intelligence and understanding formed from learning and experience, and on the other hand how one’s active mentality is driven. Our desire, volition and striving which comes from a part of the mind – a third faculty if you will – conation
Cognitive – intelligence
Affective – emotions
Conation – how one acts on those thoughts and feelings
Risk is a key investment measurable, along with return, taxation, liquidity, fees and time. It stands to reason; we can manage that which we can measure. Where we invest is measurable. But just as in life itself there are multiple aspects to risk which don’t necessarily have a direct link to investment, but certainly have a direct link to wealth creation. I refer to strategies such as cash management and estate management.
In the financial planning profession, a top notch financial adviser is principally a professional risk controller. That person could specialise:
a commercial property broker in mortgage and lending; or
a futures trader in US equities; or
a life and business insurances broker
A financial planning generalist is likely to specialise in the planning function and refer some or all of the specialist areas to alternative professionals either internal or external. The three principal areas of total financial planning are:
- Cash management
- Insurance and estate management
Each has critical factors for which risk control is important and a good ‘risk controller’ understands and incorporates them within a well-constructed overall plan. As with daily decisions and daily disciplines however, any ‘plan’ is subject to a collection of expected outcomes. Goals and aspirations. And this is the most obvious missing link in people’s lives
- Purpose and meaning
- Goals and aspirations
- Destination and journey
What often prevents – purpose and meaning or goals and aspirations, is fear of the unknown and investment is a good place to start when it comes to setting goals – because many people are challenged in their thinking when it comes to investment. Risk becomes an inhibitor, just as it can be when; learning to drive, seeking a partner, choosing a career, competing at sport, speaking in public, singing a song, writing. The majority of us probably had less inhibition when we were young than we have today – which means ‘our risk’ is a fear of what others may think. It certainly is exemplified by the herding instinct of investors.
Risk and return are inexorably linked in investment as in life. Low risk, low return – whether managed funds, direct equities, property, business or speculation. And in life, career versus self-employment. Current employment versus alternative employment.
In Capital markets (predominantly publically listed companies) risk is measured via standard deviation. The likelihood that returns will equate to the mean (the average) at any given point in time. A higher risk portfolio (growth or aggressive) will likely have a standard deviation of 13% and a 50/50 portfolio a standard deviation of 6%. The likelihood or percentage outside the mean.
The problem arises for investors when capital markets fluctuate due to various political and economic events. When capital market prices decline many investors equate volatility with loss. They equate risk as the likelihood of loss. The more aggressive portfolio long term pre-tax return was probably 9.5% and the balanced fund 7.5%. Unless the investment timeframe therefore was short the investors in managed funds with conservative or defensive asset allocations will ‘risk’ under achievement. Just as occurs with an overly conservative approach to sport, or life, or business. In our book the ABC of Financial Literacy we equate the ‘sloth’ with standard deviation. Sometimes in life it pays to take some time to acquire more knowledge before embarking on an activity – or choosing one aspect of investment against another.
Purposeful and successful people have direction, passion and are planned with what they do. They are controlled risk takers.
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