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The
following article is the second in a series of exclusive
articles for Mind Like Water on socially responsible
investing (SRI) and
financial planning. The author,
Jim Horlacher, MBA, is a
professional member of First
Affirmative Financial Network (FAFN), a
nationwide network of investment professionals
specializing in socially and environmentally responsible
investing. FAFN, LLC is a registered investment advisor
with the Securities & Exchange.
I
feel like going back to school on this one because the word "risk" is so ingrained in our financial culture that it almost carries too many connotations and contradictions to be useful. Nevertheless, I use the term constantly. It's a term investors use and relate to, but maybe it's time to reframe the issue.
The problem is that risk is assumed to be proportional to probable return. The assumption is that the more risk you take, the more return you make. We also analyze mutual funds in terms of their "risk adjusted returns." Both concepts rely on the conventional notion that future risk depends on past price volatility. This means that we are really talking about volatility rather than risk.
Volatility tells us about short-term price fluctuations. It tells us nothing about what a volatile investment may be worth down the road.
Benjamin Graham, the famous author of The Intelligent Investor, observed this confusion regarding risk 50 years ago. A stock "should not be termed 'risky' merely because of the element of price fluctuation," he wrote. "An investor worries about risks to business value, since that should be the basis for the investment."
Of course you may pay advisors like me to worry about your portfolio, but it's important to remember that whether we use risk, volatility, or the recently popular term
"uncertainty," all of the terms become somewhat irrelevant over the long term. Time can help heal all
of the aforementioned risks. Why is it important to understand this? Not understanding risk may prevent you from reaching your goals. Real goals, not just making "more money." If you think an investment is risky, when, in reality, it is merely volatile, you may decide to avoid that investment and thereby miss out on the long-term return you need to reach your goals.
The opposite is also true. If you think an investment is safe just because it isn't volatile, you are in for a shock. An example of a long-term investment that has no volatility but is extremely risky is a CD. As a broad investment asset category,
CD's and other "cash equivalents" like Treasury bills are the worst performing investment in the last century after inflation and taxes. According to Ibbotson's report
"Wealth Indices of Investments After Taxes and Inflation,
1925-1994," an investment in Treasury bills LOST value at the rate of 1% per year. After 69 years, a $100 investment would
only have been worth $49 (in real dollars after inflation and taxes).
If you're investing for the long term, the acceptance of volatility may not be as risky as you think.
James C. Horlacher, MBA, July
2000
First
Affirmative Financial Network
5960
Dearborn, Suite 107
Shawnee Mission, KS 66202
Toll Free: (800) 341-0528
Phone:
(913)
432-4958
Fax: (913) 432-8951
E-mail:
TreeHuggerJim@aol.com
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