Reckoning with Risk (7): Widening Your Lens

Tadas Viskanta wrote a wonderful piece this week making the observation (as he had in his very fine book) that “the only low-hanging fruit for investors these days has to do with strategies and tactics that lie outside the realm of portfolio management. These include maximizing tax benefits through aggressive tax loss harvesting and optimal asset class location.”  He thus suggested that we invoke “a broader definition of alpha.”

If the goal of investing is to live a richer, fuller life and the opportunities by doing it through traditional investment techniques seems limited then it makes sense to look elsewhere. Beefing up our savings, more conscious consumption and investing in things, like education, that have the potential to generate returns in excess of financial markets all have the ability to increase our well-being without taking on more financial risk.

Within the investment context specifically, this approach means minimizing fees and expenses and tax efficiency (which is, of course, much more than tax loss harvesting).

I made a similar, if broader, recommendation in my 2012 Investment Outlook back at the beginning of the year.

Now is also a good time for individuals to guarantee value if not return by paying down debt, refinancing where possible, reducing consumption and reducing spending. They should consider giving more away too. While they are not investments per se, these actions will pay remarkable “dividends” immediately and will strengthen consumers’ financial position substantially so that when the next secular bull market comes around – as it inevitably will – they will be in a position to take advantage of it (emphasis in original).

What Tadas describes as “a broader definition of alpha,” I think of as widening one’s lens to see the bigger picture of opportunity and risk. Actively managing one’s life by “paying down debt, refinancing where possible, reducing consumption and reducing spending” – saving (much) more in general – is a fabulous risk management and mitigation strategy. 

The ideal approach in this regard can and should get even broader still.  I had dinner with Moshe Milevsky this week and he described a bit of his own investment process to me (besides being gracious and generally insightful).  One thing that stuck out was his 100% equity allocation.  He does that because he expects to work for at least 20 more years while his job (as a tenured professor) is very secure and provides a decent pension, but doesn’t have the upside potential of other choices he could make.  His life is thus very “bond-like” (even if  not “Bond-like”).  This concept is a key point of his forthcoming book (updated from an earlier edition).  Moshe argues that we need to be aware of the value, potential return and risks of our own “human capital” (job and career as opposed to investment choices) to plan a solid future. 

If your career is very secure you may be more aggressive with your investments.  But if your career is likely to suffer a good deal of volatility (perhaps you’re engaged with a speculative start-up or work at a hedge fund), your investment strategy should be adjusted accordingly.  Similarly, if you work in real estate or own your own home, your asset allocation ought to be reflective of that.  Your financial planning should also reflect where you are in the life-cycle, mortality risks (do early heart attacks run in your family?) and any social capital you may have. 

Dealing with investment risk is insufficient if you don’t deal effectively with the broader risks you face in life.  When reckoning with risk, widen your lens to see the bigger picture.  Once you have evaluated it, actively manage your life so as to take advantage of the opportunities you see and to protect against the risks you face.  After all, risk is always risky.

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My Reckoning with Risk series:

• Reckoning with Risk (1) begins to look at how to deal with risk.
• Reckoning with Risk (2) explains and categorizes different elements and types of risk.
• Reckoning with Risk (3) shows our failings at dealing with low-probability, high-impact events.
• Reckoning with Risk (4) looks at what the Yale Endowment experience can teach us about risk.
• Reckoning with Risk (5) explains that professional managers face different risks than those for whom they manage money and that those differences matter.
• Reckoning with Risk (6): 9.11 Edition takes a look at “black swan” risks.
• Reckoning with Risk (7): Widening Your Lens suggests that dealing with risk requires that you actively manage your life.