Liability risks – longer term risks to financial security
This<![if !vml]><![endif]>risk is represented by the financial consequences of a stock market crash or a prolonged bear market.
This is a risk to financial security since it can take between 5 and 10 years for the market to regain its original level following such risks and sometimes much longer and, this is without even taking into consideration the effects of inflation.
Such falls in the market are more often than not preceded by high to excessive market valuations and advanced economic cycles. Market falls are therefore often accompanied by difficult economic conditions such as a recession.
Importantly they are natural risks and they are known risks. A market has historically had a major collapse at least every 10 to 15 years, so a retired individual will need to be able to cope with at least 2 and possibly 3 such events.
This is the risk most investors should be concerned about when they are expressing aversion to risk.
While this risk will affect most portfolios throughout their lifetimes, it is most pronounced for investors who are investing from cash at high market valuations.
Investors who have been invested for a long period of time will not be as badly exposed because the high market valuations are reflected as gains in their portfolio.
Those most at risk will be those investors who are in receiving basic retail wealth management services, those receiving model portfolios with high charges and where the size and timing of financial needs are not related to portfolio structure.
Those least exposed to this risk over the short term will be those investors who either do not need to capital or interest from capital or those who live entirely off dividends and income and who will never need to touch their capital. <![if !vml]><![endif]>
Investors need to remember that it is not really companies that become over valued, rather the prices that investors are willing to pay for them become far too high.
It is also important to remember, most normal market movements have little or no impact on the ability of assets to meet financial needs. Most downward movements can be recovered in days, if not weeks or months. Even a couple of years is not a really significant risk event.
Portfolios that are not properly constructed could indeed become exposed to even monthly investment risk or volatility, while properly constructed portfolios could protect financial needs for up to 10 years, depending on the way in which your manager constructs portfolios.