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What is Financial Risk?

What is Financial Risk?

March 10, 2019

Risk is a topic that gets a lot of attention in the financial planning business. But it’s a term that’s not really well understood. There are many technical definitions of financial planning risk. And there is the Webster’s Dictionary definition of risk:

1.   The possibility of loss or injury.

2.   The chance that an investment (such as a stock or bond) will lose value.

But my 18 years in this business has taught me a more practical definition that reflects people’s experiences and concerns:

For most clients, risk is the chance that the performance of their investments will be different from what they expected.

Financial planning risk assessment

To me, as a CERTIFIED FINANCIAL PLANNER™ professional and investment fiduciary, I think that this definition puts the responsibility for managing risk squarely on me. It’s my job to understand the client’s goals and manage their investments consistently with those goals.

Here is my approach.

It’s very important to understand the changes in value of your investments over time. That’s because your investments will change in value over time. They will go up sometimes and down other times.

In fact, history shows that volatility in stock price normal. Since 1980 the S&P 500 has averaged a decline during each calendar year of 13.9 percent and delivered positive returns for the calendar year 29 out of 39 years and delivered 8.4 percent average growth per year.

So it’s not a question of whether your account will fall in value. Instead, all of these questions are relevant:

  • When will it fall in value?
  • How far will it fall in value?
  • How long with the value stay low?

There is no good way to know the answers to these questions. And that uncertainty is the risk you face in your investments.

Managing financial risk

My approach to manage that risk is this:

  • Remember that stocks are historically the most reliable way to grow wealth faster than inflation. You need your savings to grow faster than inflation so that when you come to spend it you can get the same utility from it at the future time as you would get from spending that money now.
  • Remember that if you own stocks for 10 years, you have a 96 percent chance that your investments will grow in value. Only four times in the last 118 years was the 10 year return negative. And during that period, the average 10-year return was 10 percent.

  • Be clear about when you need money. If you need it soon, you must take less risk. If you have more time, you can ride-out more volatility.
    • Any money you reasonably expect to spend in the next 18 months should be in a savings account at the bank.
      • Money you will need to pay a tax bill in April, or you will need for a kids’ tuition bill in September, is not an investment. It’s cash that you want to be sure is safe until you need it.
      • You don’t need to get interest on this money, although you might get 1 percent interest or a little more at most banks.
      • You do need to keep this money safe from loss of value and easy to access in the event of an unexpected need.
    • Money you reasonably expect to need some time between 18 month and three years should be invested in short-term bonds. A one-year Treasury bill will pay about 2.55 percent today.
    • Money you will not need for three years can reasonably be invested in a 45 percent stock and 55 percent bond account and expect a return of about 4.5 percent a year.
    • If you have five years or more, you can reasonably invest in an 80 percent stock to 20 percent bond portfolio and expect to receive about 6 percent over the next five years.

Financial planner to help with risk

You may talk with some financial planners who throw around a few technical terms about risk. Be careful. I believe it’s every client’s right to fully understand what they own and why they own it. Ask questions and expect to understand the approach and philosophy that will guide your investments.

If you are looking for a great financial planner, it’s a great time to visit with a CERTIFIED FINANCIAL PLANNER™professional. Start your search here. The link will let you see CFP® professionals near you.

As you visit with financial planners, I suggest a couple things to check:

  • Is the advisor always the client’s advocate – a fiduciary advisor?
  • Is the advisor only paid by clients, not any financial product manufacturer or distribution network? That would be a fee-only advisor.

These two points help assure that you are working with a professional who is committed to your best interest at all times. It seems sort of obvious to me that a professional would work in this way, but it’s not automatic.

A fiduciary, fee-only, CFP® professional can help you create a financial plan that is driven by your goals and priorities and addresses all aspects of your financial life. With a big-picture approach, you will be better prepared to understand your options at every step along the way.

Yes, I am a CFP® professional. I’m always a fiduciary and I only work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice.

If this article has you thinking about the risk to your financial goals, contact my office at I am always happy to meet with people who are working to understand risk in their investments. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.