JUST PLAIN TALK: Ignore risk at your peril
Six months ago, being an Airbnb landlord seemed a path to riches, "Hold my beer,“ said the coronavirus.
Above-average returns involve higher risk; it is an investing axiom people forget or discount. In 2008, the financial system meltdown shook local real estate, and natural disasters work similarly. Six months before Hurricane Michael ravaged South Georgia, I made the final payment on an irrigation system.
Now I’m making payments on a new irrigation center-pivot, and 60% of my timber was lost. Rental property has risks.
Risk is difficult, perhaps impossible to measure, unlike temperature. Studies show individual risk tolerance tests are imprecise. During boom times, people score higher on risk tolerance tests and the opposite during periods with poor returns. There is a vast and visceral difference between saying a 20% decline is tolerable and seeing your investments decline 20%. The phrasing of questions influences answers and strangely enough, even the time of day. Only Vulcans like Mister Spock answer risk tolerance questions logically.
Risk tolerance does not stand alone; Risk capacity, the ability to weather risk, has to be considered along with the need to take risk. It would be foolhardy for someone even with a high tolerance for risk to take any chances with funds for a house down payment. Retirees should, in general, take the least amount of risk to reach their goals. All three have to mesh for optimal allocation. Some people, relatively few, are investing for the next generation and can afford to take more chances with their money.
Even investment professionals struggle with risk. A November 2019 headline in The Wall Street Journal boldly proclaimed "Pensions Embrace Riskier Investments." With yields on bonds stubbornly low, pension managers felt compelled to venture away from staid fixed-income investments. In response, they ventured into real estate investments, with some pensions taking positions in emerging market debt. Private real estate investments, like the South Walton Fire District’s pension owns, have subjective valuations. Trying to determine the value of a non-traded investment is impossible. It's one thing when an individual invests in a vehicle with a hard-to-determine value; that’s their choice, but with a pension, taxpayers are on the hook.
Fast forward six months, we see state and local government pensions with their worst quarter since The Great Recession. Unfortunately, the decline followed a period where fund managers felt compelled to take additional risks. Public pensions use expected returns around 7%, which almost assuredly won't be met. With the shortfall, state and local governments will have to increase funding, or employee contributions will have to rise. Deferring these expenses only increases unfunded liabilities.
"Uncle John's Band" was The Grateful Dead's first Billboard 100 hit. While it was far from his intention, Robert Hunter's lyrics, in a roundabout way, sum up risk. "When life looks like Easy Street, there is danger at the door."
You can’t always get what you want, but Buz Livingston, CFP, can help you figure out what you need. For specific advice, visit livingstonfinancial.net or drop by 2050 West County Highway 30A, M1 Suite 230.