Our research shows 90% of investors cannot identify common measures of risk, yet 80% of investors consider themselves at least somewhat knowledgeable about investing. This gap in understanding presents an opportunity for advisors to add value for their clients by building a shared understanding about risk and diversification.
Many investors don’t understand risk in a time when there’s deep skepticism on gaining advice and increasing awareness of robo-advisors. That provides financial advisors a unique inflection point to showcase value through education and advice on investment risks.
Only 9% selected standard deviation and/or beta. We’ll call them knowledgeable investors and the other 91%: unknowledgeable.
Unknowledgeable investors are clearly demarcating their interest in scenario planning and if unable to get truly customized advice, may seek new outlets.
The first step to protecting investors is to educate on the basics about risk. We’re not talking about risk budgeting and modern portfolio theory stuff made for CFAs.
Risk involves the chance an investment’s actual return will differ
from the expected return. Risk includes the possibility of losing
some or all of the original investment.
Then, how do people measure risk? By calculating the standard
deviation of previous returns. The bigger the standard deviation,
the greater the risk of an investment. The top illustration
represents less risk than the bottom illustration.
For example, your investment value might rise or fall because of market conditions (market risk). Corporate decisions, such as whether to expand into a new area of business or merge with another company, can affect the value of your investments
(business risk). For those who own an international investment, events within that country can have a significant impact on its performance (political risk and currency risk, to name two).1
Both can be described simply: don’t put all your eggs in one basket. Asset allocation means your client invests in stocks,
bonds, real estate, cash and other investment categories. In most environments, these investments don’t rise and fall in value at the same time. Diversification means picking many different investments within each category; so not a single company’s stock but many different stocks.
Let the abovementioned research be a call-to-arms for financial advisors to educate their clients on risk. It all begins with that phone call or e-mail and can only improve client satisfaction.
Diversification does not guarantee a profit or protect against a loss in declining markets. All investments are subject to risk including possible loss of principal.
1 Via http://www.finra.org/investors/reality-investment-risk
Standard deviation is a statistical measure of the range of a portfolio's performance. A high standard deviation suggests a wider range of returns and indicates that there is a greater potential for volatility. By definition, approximately 68% of the time, the total return is expected to differ from its mean total return by no more than plus or minus the standard deviation figure. Ninety-five percent of the time, the portfolio's total return should be within a range of plus or minus two times the standard deviation from its mean. (These ranges assume that returns fall in a typical bell-shaped distribution.) For example, an investor can compare two portfolios with the same average monthly return of 5.0%, but with different standard deviations. The first has a 3-year standard deviation of 2.0, which means that its range of returns for the past 36 months has typically remained between 1% and 9%. On the other hand, assume that the second has a 3-year standard deviation of 4.0 for the same period. This higher deviation indicates that this portfolio has experienced returns fluctuating between -3% and 13%.
All investments are subject to risk including possible loss of principal.
Wealth Management Trends in America is a study conducted by AMG Funds among 1,000 investors across the U.S. with $250K+ in investable assets. This study took place from November 28 to December 16, 2016 and the results offer a unique and timely window into investors’ mindsets. Throughout the results, we refer to Millennials (ages 18–35), Gen Xers (ages 36–51) as well as Boomer+ (ages 52 and older) to highlight the many differences by age.
Successful long-term investors use asset allocation and diversification as they seek to achieve return streams that match their risk and return preferences. These fairly straightforward principles have historically been among the most effective strategies for helping to meet long-term investment goals.Read Full Perspective
When life circumstances and priorities change—as they inevitably will—so too will financial goals. Only those who employ a holistic approach to planning can easily identify and address the areas that may be hindering their financial well-being.Read Full Perspective
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