What is risk, anyway?
That question seems to have an obvious answer, but the idea of "investment risk" is a lot more slippery than you might think. Can you calculate it from the past volatility of an investment's price, as some academics suggest? Is it related to the track record and condition of a security's issuer, as bond rating agencies say? Is it something we can quantify at all, at least when it comes to real portfolios and real money?
The answer to all those questions is "yes and no." That's not particularly helpful, I realize. But when talking about my own portfolio and my own retirement planning, I can boil the idea of "risk" down to this: Will I have enough money to live well when I retire?
Breaking it down
This month's issue of the Fool's Rule Your Retirement newsletter, available online at 4 p.m. ET today, examines the question of risk as it affects our retirement investments from a number of different angles. Of course, the basic risks around retirement savings are obvious:
- How much am I saving now? The "risk" components here include things I can control -- am I choosing to spend money I could and should be saving? -- and things I probably can't, like whether an economic shift will lower my income in the future.
Will I lose money in my investments? This isn't necessarily related to an investment's volatility. A stock like SanDisk
(NASDAQ:SNDK)may make huge price swings, even while the company's underlying fundamentals remain strong, and the overall trend remains more or less upward, for example. It's more about the size of your bets on any given company's prospects, and the odds of those bets working out. A long-term bet on General Electric (NYSE:GE)is relatively safe: GE's share price will fluctuate, but the company's diversified business lines and tradition of strong management should yield good (if unexciting) results over the long haul.
Will I make enough money in my investments? Here's the flip side of the above question. You can put all your money in Treasuries and reduce your downside risk to zero, but you'll have to be content with returns in the 5%-6% range, for the most part. You'll also have to accept the risk -- yes, it's a risk -- that those returns won't give you enough money to retire in comfort. Alternatively, you can bet the farm on an up-and-coming technology firm like service-management software maker SupportSoft
(NASDAQ:SPRT)and have a decent chance of market-beating returns -- but with a significantly bigger risk of loss.
Most well-informed investors have a pretty good understanding of how to manage the risks listed above:
- Save as much as you can.
- Practice smart asset allocation.
- Don't put too much of your portfolio in emerging companies, or in single-product companies like Heelys
But other risks surrounding retirement investing are less well-understood by average investors. In the new Rule Your Retirement newsletter, advisor Robert Brokamp explores three of these risks in an interview with Dr. Moshe Milevsky, an international expert on risk management, and author of The Calculus of Retirement Income. As Dr. Milevsky points out, your investment performance (or lack thereof) is just one part of a risk equation that also includes potential loss of purchasing power and the possibility of outliving your savings, among other factors.
In the interview, Dr. Milevsky offers some specific ideas for investors, including an excellent idea for mitigating all the risks investors face. While I have to save the answers for subscribers (although you can grab a free month-long guest pass here), I do believe that if you're approaching retirement age, or have recently made the transition to retirement, Dr. Milevsky's suggestion merits serious consideration, particularly given the recent turmoil in the global markets.
You can read the interview and access our entire Rule Your Retirement library -- with back issues, discussion boards, and a unique set of planning tools and calculators -- by clicking here for a complimentary 30-day trial. There is absolutely no obligation to subscribe.
Fool contributor John Rosevear can babble on about retirement investing for hours, which is a little weird for a guy who's only 40. He does not own any of the stocks mentioned in this article. The Motley Fool's disclosure policy plans to spend its vast retirement portfolio on a huge estate in the south of France, but probably not for a few hundred years yet.