Common Misconceptions of Investment Risk

The word risk is one of the most commonly used terms in investing. With that said, we also believe it is one of the most misunderstood. Investors today have many different ideas and predispositions as to what investment risk actually is. We’ve taken some time to discuss common misconceptions and how we think about risk from those perspectives.

1. An Asset Going Up Has Low Risk

Investors often believe that there is less risk when an asset is moving higher or in an uptrend. This is a huge misconception, because risk can increase when an asset is going up and down. Both directions are extremely important when calculating the risk level of an asset.

Risk should be evaluated during rising and falling periods. This will provide investors a better picture for the asset’s risk and allow them to not be caught off guard or become complacent in an up-trending market. It also gives the ability for an investor to take earlier action should a large spike in risk occur.

2. All Risk Should Be Treated Equally

Many investors view all types of risk through one lens and don’t understand how each can impact their portfolio. Risk comes in different shapes and sizes. For example, the loss potential of owning an individual security can be significantly greater than owning all the stocks in its sector. An investor can get the sector right, while being wrong on the stock and significantly negatively impact their portfolio.

We believe risk should be evaluated on multiple levels. Trying to predict what type of risk will be the cause of a loss is virtually impossible. It’s important to understand the varying levels of risk exposure within a portfolio and how the assets are correlated to determine the magnitude of the asset’s potential loss.

3. VIX = Risk

Investors closely monitor the VIX index and use it as a barometer for risk in their investment portfolio. This is dangerous for an investor, especially considering that the VIX is only based upon one index, the S&P 500, and is constructed using the implied volatilities of a wide range of options contracts. The largest issue is that because the VIX only provides insight relative to the S&P 500, it does not consider other asset classes and segments.

Instead of solely looking at the VIX as a proxy for risk, we believe each asset in a portfolio should be evaluated. This gives a more accurate representation for the risk of a portfolio highlighting how its assets are interacting with each other and are responding in various market environments.

4. More Risk Equals More Return

Typically, investors expect more return when they take on more risk. But historically we’ve seen instances where more risk doesn’t always equal more return. Over shorter-term periods riskier assets can result in higher returns as compared to a lower risk portfolio, which can be misleading. These higher returns come at a cost. The severity of potential losses can more than offset the higher returns.

We believe investors should avoid the temptation to focus on a particular, concentrated asset that may have the potential for a high return. Instead, they should look at how a diverse group of assets can work together to meet investment objectives. A diversified portfolio with multiple asset classes (stocks, bonds, and real assets) can outperform a portfolio that is allocated 100% to equities over the long term with lower overall risk.

Risk comes in many forms and can be analyzed from various viewpoints. Risk is also much more than just simply looking at volatility. It takes true analysis and a deep understanding of potential investment risk to be able to provide investment solutions that perform how advisors and their clients expect them to. We take great pride in our quantitative assessment of risk and strive to put it at the forefront of our asset management decisions.

THIS DOCUMENT HAS BEEN PREPARED BY PARITAS CAPITAL MANAGEMENT, LLC (“PARITAS”) SOLELY FOR THE PURPOSES OF PROVIDING SUMMARY INFORMATION REGARDING PARITAS AND ITS GLOBAL WEALTH STRATEGY (“GWS”) COMPOSITE. THE INFORMATION CONTAINED HEREIN IS NOT, AND SHOULD NOT BE CONSTRUED, AS AN OFFER OR SOLICITATION OF AN OFFER TO BUY ANY FINANCIAL INSTRUMENT. AN INVESTMENT IN ACCORDANCE WITH THE GWS COMPOSITE DESCRIBED HEREIN HAS NOT BEEN APPROVED OR DISAPPROVED BY THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION (“SEC”), ANY STATE SECURITIES COMMISSION, OR OTHER ANY OTHER REGULATORY AUTHORITY, NOR HAVE ANY OF THESE AUTHORITIES PASSED UPON OR ENDORSED THE MERITS OR THE ACCURACY OR ADEQUACY OF THIS DOCUMENT. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL AND A CRIMINAL OFFENSE.

ANY REPRODUCTION, DISTRIBUTION, OR OTHER UNAUTHORIZED USE OF THIS DOCUMENT, AS A WHOLE OR IN PART, OR THE DISCLOSURE OF THE CONTENTS HEREOF, OTHER THAN TO THE RECIPIENTS FINANCIAL, TAX AND/OR LEGAL ADVISORS WITHOUT THE PRIOR WRITTEN CONSENT OF PARITAS IS PROHIBITED.

THE BENCHMARK INDEX REFERRED TO HEREIN IS A BLEND OF 60% MSCI ACWI INDEX AND 40% BARCLAYS US AGGREGATE BOND INDEX. THE INDICES INCLUDED TO SHOW RELATIVE MARKET PERFORMANCE FOR THE PERIODS INDICATED ARE NOT NECESSARILY STANDARDS OF COMPARISON, SINCE INDICES ARE UNMANAGED, BROADLY BASED AND DIFFER IN NUMEROUS RESPECTS FROM THE GWS COMPOSITE. MARKET INDEX INFORMATION WAS COMPILED FROM SOURCES THAT PARITAS BELIEVES TO BE RELIABLE. HOWEVER, PARITAS DOES NOT GUARANTEE THE ACCURACY OR COMPLETENESS OF SUCH DATA.

AN INVESTMENT IN ACCORDANCE WITH THE GWS COMPOSITE MAY NOT BE SUITABLE FOR ALL INVESTORS. THIS MATERIAL HAS BEEN PREPARED FOR INFORMATIONAL PURPOSES ONLY, AND IS NOT INTENDED TO PROVIDE, AND SHOULD NOT BE RELIED ON FOR, INVESTMENT, ACCOUNTING, LEGAL OR TAX ADVICE.

INVESTING INVOLVES RISK, INCLUDING THE POTENTIAL OF LOSS OF SOME OR ALL PRINCIPAL INVESTED. INTERESTED PARTIES ARE ENCOURAGED TO REVIEW PARITAS’ FORM ADV PART 2, AS WELL AS PERTINENT PROSPECTUS/PRODUCT DESCRIPTIONS TO CONSIDER SUCH RISK PRIOR TO INVESTING. THERE IS NO GUARANTEE THAT A DIVERSIFIED PORTFOLIO WILL ENHANCE OVERALL RETURNS OR OUTPERFORM A NON-DIVERSIFIED PORTFOLIO. DIVERSIFICATION DOES NOT PROTECT AGAINST MARKET RISK. STOCK INVESTING INVOLVES RISK INCLUDING LOSS OF PRINCIPAL. PAST PERFORMANCE IS NO GUARANTEE OR PROMISE OF FUTURE SUCCESS.

THE SHARES OF EXCHANGE-TRADED FUNDS (“ETFS”) MAY TRADE AT PRICES AT, BELOW, OR ABOVE THEIR MOST RECENT NET ASSET VALUE. EQUITY SECURITIES WILL FLUCTUATE IN PRICE; THE VALUE OF INVESTMENTS IN ACCORDANCE WITH THE GWS COMPOSITE WILL THUS FLUCTUATE, AND THIS MAY RESULT IN A LOSS. SECURITIES IN CERTAIN FOREIGN COUNTRIES MAY BE LESS LIQUID, MORE VOLATILE, AND LESS SUBJECT TO GOVERNMENTAL SUPERVISION THAN IN THE UNITED STATES. THE VALUES OF THESE SECURITIES MAY BE AFFECTED BY CHANGES IN CURRENCY RATES, APPLICATION OF A COUNTRY’S SPECIFIC TAX LAWS, CHANGES IN GOVERNMENT ADMINISTRATION, AND ECONOMIC AND MONETARY POLICY. EMERGING MARKET SECURITIES CARRY SPECIAL RISKS, SUCH AS LESS DEVELOPED OR LESS EFFICIENT TRADING MARKETS, A LACK OF COMPANY INFORMATION, AND DIFFERING AUDITING AND LEGAL STANDARDS.

AN INVESTMENT IN BONDS CARRIES RISK. IF INTEREST RATES RISE, BOND PRICES USUALLY DECLINE. THE LONGER A BOND’S MATURITY, THE GREATER THE IMPACT A CHANGE IN INTEREST RATES CAN HAVE ON ITS PRICE. SELLING A BOND BEFORE IT REACHES ITS MATURITY MAY RESULT IN A LOSS UPON ITS SALE. BONDS ALSO CARRY THE RISK OF DEFAULT, WHICH IS THE RISK THAT THE ISSUER IS UNABLE TO MAKE FURTHER INCOME AND PRINCIPAL PAYMENTS. OTHER RISKS, INCLUDING INFLATION RISK, CALL RISK, AND PRE-PAYMENT RISK, ALSO APPLY. HIGH YIELD SECURITIES (ALSO REFERRED TO AS “JUNK BONDS”) INHERENTLY HAVE A HIGHER DEGREE OF MARKET RISK, DEFAULT RISK, AND CREDIT RISK.

PARITAS CAPITAL MANAGEMENT, LLC IS A REGISTERED INVESTMENT ADVISOR WITH THE STATES OF CALIFORNIA, CONNECTICUT, MASSACHUSETTS, NEW JERSEY, NEW YORK, PENNSYLVANIA, AND TEXAS.

About the author: Douglas Hedley

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