Arbor Wealth: Market risk: What's behind door number three?

Staff Writer
The Destin Log
Margaret R. McDowell

“Things are mending now … I see a rainbow blending now.” — from “Taking a Chance on Love” as performed by Ella Fitzgerald

NYU Professor Aswath Damodaran, teacher of an economics valuation class, recently held up an envelope, told his listeners there was a $20 bill inside, and asked how much members of his audience would pay him for it. One fellow actually offered $25 for the envelope. Damodaran shook his head, proffered the envelope, took the man’s 25 bucks and made himself a quick finsky.

You don’t have to be the sharpest tool in the shed to know that paying $25 to get $20 back isn’t very smart. But let’s add a corollary to Damodaran’s exercise. Say someone offers us an envelope that contains somewhere between zero and $100. What would we pay him for the contents of that envelope?

In Damodoran’s exercise, we were paying for certainty. In our new scenario, however, we’re dealing with uncertainty. Let’s call it market risk. If we offer to pay $10 for the envelope and there’s nothing inside, we’ve lost our investment. But say we offer to pay $20 for the envelope’s contents and there’s a hundred bucks inside, then we’ve made a tidy profit. The point is, with capital markets, there’s always an element of uncertainty.

Some investors just cannot accommodate risk. At the first sign of market volatility, they move the entirety of their assets to cash. Their investments may even be generating income, but they can’t stand the strain when share prices fluctuate. They are not risk averse; they’re loss averse.

The opposite spectrum includes investors who can’t stop running with the bulls at Pamplona. These market speculators chase every hot IPO in search of quick fortune. They may even throw assets at non-publicly traded ventures. Income generation is less attractive to this type of investor, because he’s convinced that his “hit it rich quick” returns will outpace the smaller, systematic paydays provided by dividends and yields.

Most successful investors find their niche somewhere in the middle of these two extremes. They recognize that you have to abide some uncertainty to make money. Accepting this caveat, they focus on understanding what is knowable and measurable and ruminate on risk that can be analyzed. They grow to understand and even appreciate volatility, viewing it as an occasional buying opportunity and knowing that “This too shall pass.” They develop the fortitude to focus on where their investments are now compared to where they were three years ago, not three months ago. They concentrate on decades, not short term downturns.

The ability to live with market fluctuation and occasional volatility, and to accept steady, unspectacular returns in one’s portfolio, are often prominent factors in developing a successful and long term investment outlook.

Margaret R. McDowell, ChFC, AIF, a syndicated economic columnist, is the founder of Arbor Wealth Management, LLC, (850-608-6121 —, a “fee-only” registered investment advisory firm located near Sandestin. This column should not be considered personalized investment advice and provides no assurance that any specific strategy or investment will be suitable or profitable for an investor.