Risky Business??? Whatever do you mean?
It’s a rare occurrence (like NEVER) when someone asks us to put them in a “risky” portfolio strategy. So when I read the headline “The Risky Rich” in the WSJ Wealth Report Blog I was taken aback. A further look at the source of the information, The Barclays Wealth Report does indeed say that the wealthy do expose themselves to “riskier” investments than those in lower economic wealth categories. But do they take more risk in their wealth management and investing strategies?
Academics will often use many terms in the attempt to define risk. Terms like interest rate risk to describe the impact of the change in competitive interest rates will have on the value of fixed income investments such as bonds. Financial risk informs us that enterprises do underperform and/or fail. Names like Enron come to mind. Currency risk exposure comes from being invested in assets outside our domestic currency. Market risk, the ups and downs of the investment markets them selves, is often top of mind in wealth management especially after a serious bear market like the one recently encountered in 2000 through 2003.
When reviewing the Barclay’s report, which was very well done, I did not come to the conclusion that the wealthy got there by seeking more risk. An extreme example of risk taking for risk taking sake is that it is like bungee jumping without checking to make sure that both ends of the bungee cords are secured (really secured!) where they are supposed to be AND the cord is WAY SHORTER THAN THE GROUND. Having had the opportunity to work with successful individuals my take is that they only make investments that have above average potential for return and have mitigated risk as much as reasonably possible. They understand the risk and positioned their assets to minimize the impact of a mistake. They do recognize however, that avoiding these risks entirely will have a material and adverse effect on meeting and maintaining their long term financial security for them and their families.
In most cases it has taken many long years of blood, sweat and tears to achieve a significant amount of wealth and preserving is an important mandate in developing their wealth management strategies.
How does one mitigate risk in an investment portfolio? Sound wealth management strategies employ broad based diversification. Wealth individuals and their wealth managers make choices about allocating between domestic and international, large and small cap, fixed income of various types, real estate, alternative investments and special situations spreads out the risk among several categories. Paying attention to current valuations of assets versus their norms will provide a basis for appropriate amounts of allocation. Which to overweight and which to underweight in a portfolio further mitigates risk.
Being conservative may mean to take into account the risk of inflation eating away at the net impact of your resources over time as well. There are many ways to reduce risk. The wealthy and their financial advisors explore all the choices and make reasoned judgments about the best course of action