We often hear discussions about risk but there is no one better to explain it in detail than Ed Butowsky, a 25 year veteran of the financial services business. Butowsky says he shocked at how limited the conversation about risk really is. Most people take on the surface that risk is loss of principal. However, there are many other risks you need to evaluate when organizing an investment portfolio, he says. Below are three examples of various risks.
1. Capital Risk.
This is the easiest risk to understand. You put $100 in an investment and it drops to $80. Most people are only worried about capital risk so they are falling victim to many other risks in their portfolios that are lesser known.
2. Purchasing Power Risk.
This risk is something that everyone is falling victim to, however, the severity of each case varies. No one is immune to Purchasing Power Risk. Since many people are afraid of capital loss, they have decided to remain in money market earning basically less than 1% on their investments. Cost of living increases are rising dramatically and everybody’s lifestyle is different, however we can generally say that if you are earning 1% on your money, after taxes and the real cost of living increase, you are losing about 6% purchasing power a year.
3. Correlation Risk.
Professional money managers have been aware of this problem for years. Most equity categories are going up and down together. If all of your investments rise based on a positive economic condition, they will most likely decline together when that positive economic condition changes. The genius of investing is finding investments that can make you money but don’t have the same risk characteristics of all of your other investments. Everyone needs to know that due to the unrelenting printing of money by the Obama administration, we are seeing more assets rise together than ever before. With money being force fed into the economy due to Obama’s quantitative easing policies, all equity investments have risen together. This presents a major potential risk for all investors. Make sure to compliment your portfolios with investments that can also go up when equity prices go down.