In this post, we're going to look at risk in the context of loss.
A Loss is Only a Loss When you Sell
It’s good to think about volatility rather than risk of loss, because with investing there’s a golden rule, an eternal truth you need to remember and keep close to you. Are you ready? A loss is only a loss when you sell.
Think about it. You invest £20,000 and a year later you get a statement to say that your investment is worth £15,000. Not a great day, but have you lost any money? The answer is no, because if you look at the number of shares you hold, it’ll be the same or more than the number you originally bought. You hold the same amount of stuff, it’s just that right now, they’re worth a bit less, but only if you sell them.
They’re as likely to go back up in value, more likely in fact to increase in value in the next calendar year than they are to fall again. The only way to guarantee that you lose money is to sell the shares while they are worth less than you paid for them. Obvious, really, but we forget this all too often.
We really need to watch our language and make sure we’re not calling something a loss, when it isn’t. Really, we should say a temporary decline only becomes a loss when you sell. This is a good time to reiterate one of my favourite quotes from the legend that is Nick Murray:
“Declines are temporary, the advance is permanent”.
Here, Mr Murray is talking about the relentless advance of stock markets over time. Yes, they will pull back from time to time – that’s normal market behaviour – but the general trend will always be to increase in value.
Risk = Behaviour
If it’s true then that a loss only becomes a loss when we sell, it stands to reason that really it’s behaviour, not the market that cause losses. It is our decision to sell at the wrong time that crystallises a potential loss into a real one.
Of course, it might be that we have to sell at that given time due to circumstances. But that’s why you’ll always hear me say that your emergency fund, plus any money you can see yourself needing to spend in the next two to three years should not be invested at all.
The whole point of that is to prevent you having to make that loss, to crystallise it, by selling your assets at the wrong time. If money you’re going to need is not invested in the first place, then that’s fine – spend it.
The Only Risk That Matters: not Meeting Your Financial Goals
I absolutely love this quote from a book I haven’t read called Adaptive Asset Allocation by Butler, Philbrick and Gordillo:
“The only benchmark that you should care about is one that indicates whether or not you’re on track to accomplish your financial goals. Risk is measured as the probability that you won’t meet your financial goals. Investing should have the exclusive objective of minimising this risk.”
I love this. Investing, then, is not about avoiding the risks that are inherent in the process. It is actually about harnessing those subservient risks to avoid the biggest risk of all: that you don’t meet your potential and miss your financial goals.
We really do need to write this on our hands where we can see it all the time. Write it on a Post-It and stick it to your laptop where you’ll see it when logging into your investment. Understand the inherent volatility of markets, and in turn your chosen investments, but then accept them as necessary as you relentlessly march towards your goals.