You know how you read something but it doesn't make an impact right away but then you think about it and you realize it was pretty important or wise or powerful? The other day I saw Tweet that said something like if I were an endowment manager and one of my sub-advisors returned 45% last year I'd fire them right away because they clearly know nothing about how to manage risk.
Yesterday I wrote a little about the GameStop (GME) saga and it looks at though the music may have stopped on that one after a few glorious weeks for early bettors from the r/wallstreetbets subreddit. The half life on their foray into silver may have ended after just one day. Anyone who bought GME in the teens and watched it go up into the hundreds of dollars, close to $500 for one brief moment and well above $300 for many hours and is still in a little over $100 without having sold any has no concept of risk management.
Risk management isn't about getting the trade exactly right but if we are lucky, we'll get one or two crazy opportunities like the one some people were given with GME in our investing lifetimes. It is crucial to recognize them for what they are and be willing to at least partially ring the bell. It is not a stretch to think that some of the members of r/wallstreetbets bought 1000 or 2000 shares at $14 or $15 and a month later were sitting on paper gains of hundreds of thousands of dollars. Some sold of course but if you look around the personal finance sites you'll see anecdotes from people who haven't sold...yet?
One form of risk management is setting an exit strategy before you go in. This pertains to speculations like GME for example or Bitcoin. There are different forms of risk management for making allocations to asset classes. If you're 45 and allocate 65% to equities via a broad based index ETF, setting an actual exit point doesn't really make sense, there are other ways to manage the risk of that type of position.
I've been transparent about my gamble on Bitcoin. I invested less than a Roth IRA contribution when it was around $3200 in Dec 2018. I've been clear about my exit strategy, that I would hold it until it either grows big enough to change our life financially or it goes to zero. The gain has been nice but it is nowhere close to being a life changing piece of money and I have no idea if that will ever happen but that is the strategy and setting that objective on the way in has made it easy to stay on plan with it.
A less dramatic form of risk management is what I try to do in managing client portfolios and more akin to the example above about a broad based allocation to equities. Meb Faber shared a link to an article written during the internet bubble that has plenty of relevance today. This quote jumped out at me about the role of financial advisors.
"Our job is not to get you rich." You had to be reasonably rich to qualify to be a client. Our job is to preserve your principal and your income in real terms and perhaps do a little more if we can without assuming unreasonable risk.
This captures where we are now. The stock market is doing things it should not be doing in terms of doing very well despite a miserable story on the ground. As we talk about frequently here, this sort of thing is not unusual in the slightest but it is these types of environment where risk is heightened, the risk of some sort of ghastly, "I didn't know they could drop this much" type of crash. That is not a prediction, it is simply an acknowledgment of increased risk for the stock market, risk that has to be addressed in the portfolio to avoid "assuming unreasonable risk" as noted in the above quote but also to preserve the portfolio's ability to do whatever it is supposed to be doing right now for each client.
The outcome doesn't have to be that you get everything exactly right but that you get enough right to avoid most "unreasonable risks" and avoid most potential lifestyle disruptions. I've written hundreds of posts about how I do that with alternative strategies. Just like the music may have stopped for GME, if not yet it will at some point, it will stop for this market cycle, there will be a hideous decline and then a new cycle will start. This is how it works. Risk management is about trying to reduce the impact of those potential and unpredictable (unpredictable as to timing) hideous declines have on your financial life.