X-Ray Investing — Invisible risks can have an even bigger impact on your portfolio than the ones you see every day. Do you know where you'll find them?
By Caralee Adams
Short-term blips in the market—urgently reported on the nightly news whenever the Dow moves up or down—can sometimes spook investors. Risk suddenly becomes visible. Most experts will tell you, however, that over the long term, visible risk is an insignificant threat to your portfolio compared to invisible risk.
What is invisible risk? It includes factors such as inflation, which can eat away at your retirement assets without ever being noticed. "There is nothing without risk in life—especially in the investment area," says John Jones, a senior financial consultant with Thrivent Financial for Lutherans in Greenville, South Carolina. "The key is to identify and manage risks."
Jones says the best investors take emotion out of the equation and look to the long term for results. That means factoring in not only their tolerance for market volatility (a visible risk), but also things such as inflation or using an overly conservative investing style (invisible risks), and the unexpected impact they can have on their financial picture.
When it comes to invisible risks, here are three to consider:
Invisible Risk #1:
Inflation
Avoiding the stock market does not necessarily mean avoiding risk. Instead, it can mean avoiding visible risk while subjecting yourself to greater invisible risk, such as the risk that your savings may not keep up with inflation.
You may think you're "playing it safe" by socking your money away in a savings account earning 2 percent. But, once you factor in the long-term decrease in the purchasing power of a dollar, you may be losing money, says Jones. While the direction and amount of inflation is unpredictable, investors still should consider inflation as an invisible risk.
For the long-term investor, stocks (and stocks-based mutual funds) can be a great way to stay ahead of inflation. The average annual return of the S&P 500 from 1926 to 2004 was 10.4 percent. Compare that to the annual rate of inflation-the percentage change in the Consumer Price Index-over that same period, about 3 percent, and you can see how stocks historically have beat the invisible risk of inflation.
Invisible Risk #2:
Being Overly Conservative
Even investors who do invest in the stock market overlook the risks they assume by investing too conservatively, says Mark Simenstad, vice president of fixed income mutual funds for Thrivent Financial.
Over-investing in highly liquid accounts (accounts that grant immediate access to cash), such as a bank savings account or money market fund, and in more conservative mutual funds that offer generally lower returns, can mean you're leaving potential returns on the table. "Generally speaking, younger investors don't need to be as liquid as they think they do," Simenstad says.
Experts generally suggest moderate, long-term investors have about 50 to 60 percent of their portfolios in stocks. Those in their 20s, 30s and 40s who are comfortable with a more aggressive approach might consider having up to 80 to 90 percent of retirement assets in stocks.
Jones often discovers new clients haven't considered whether their investment style—from conservative to aggressive—matches their asset allocation. "A key to successful long-term investing is understanding your investment style and why you should adhere to it. A strategic plan with the ability to make tactical changes is very important," says Jones.
Invisible Risk #3:
Poor Asset Allocation
Failing to rebalance your portfolio on a regular basis simply means you risk an opportunity to sell high and buy low, says Jones. As asset classes fluctuate in value over time, so too can your relative distribution by asset class. Even the most well-designed plan can "invisibly" become unbalanced over time.
The solution: Investors should review their portfolio annually with a professional or whenever a big life event, such as a job change, occurs. These reviews are a chance to make slight changes to help an investor's long-term financial picture. "Don't get caught up in market timing. Avoid short-term thinking," says Jones.
Thrivent Financial offers a short questionnaire to help investors review their attitude and approach to allocating their investments between stocks, bonds and money market securities. Investments can then be allocated based on individual goals, timing and risk tolerance.
Taking the time to consider all risks—visible and invisible—is more critical than ever, says Jones, since the burden of retirement planning today rests on individuals. He recommends that his 30-year-old clients, for example, sock away 20 percent of their pre-tax income in a retirement savings account. Simenstad concurs: "Younger investors have to take ownership of their savings," he says. "There is not going to be a corporate check down the road." Not saving enough, it seems, is the biggest invisible risk of all.
Maryland writer Caralee Adams wrote "This Is Your Life ... Insurance" in the May/June 2003 Thrivent magazine.
Find help here
For more information on managing your investments and monitoring market risks, visit www.thrivent.com/investments.
A Tip for Managing Risk
According to Russ Swansen, senior vice president and chief investment officer at Thrivent Financial for Lutherans, the best way to manage risk is through asset allocation. Studies have shown that asset allocation is the main contributor to your investment portfolio's performance. "Asset allocation is a strategy that reduces risk because it allows you to spread your savings across a variety of different investment types. That way you temper the volatility of individual investment classes from year to year," he says.
The new Thrivent Asset Allocation Funds offer a simple way to achieve asset allocation. According to Swansen, these funds are simple because they provide investors with one decision to make and one investment to track. They're smart because these funds incorporate all the important investment principles: allocation, diversification, reallocation and ongoing investment advice.
The four managed funds, which range from moderately conservative to aggressive, automatically allocate assets across a variety of investment types to meet the specific goals of the fund. "The mix of underlying funds creates diversification, which helps provide balance in your portfolio—and potentially increases your opportunity for success," says Swansen. What's more, the different types of investments within the funds are evaluated quarterly and adjusted as needed, based on Thrivent Investment Management's market outlook.
--Linda Fjeld
Investing in a mutual fund involves risks, including the possible loss of principal. The prospectus, which investors should read and consider carefully before investing, contains more complete information on the investment objectives, risks, charges and expenses of the investment company. To obtain a prospectus, contact a registered representative or visit www.thrivent.com/investments.
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