Is Investment Risk Rising or Falling?

In a recent article titled Rethinking Risk, Jack Raines had this to say about today's investing environment (emphasis is that of the author),

"It was far, far riskier investing a year and a half ago than it is today. Interest rates are returning to their historical range, the S&P's earnings are back at a healthy level, excess liquidity is leaving the system, and you can no longer make easy money playing hot potato with a worthless asset. …Risk happens in the past, and we act on it in the present. We think, 'All of these bad things happened over the last 12 months, now is a horrible time to be in the market.' While we should think, 'A lot of the bad stuff is out of the way, now is a great time to invest more money in the market.'"

When prices fall, it often feels like risk is rising. The irony is that it's the opposite that's true—generally speaking, risk falls as prices fall.

To this point, Raines said,

"Risk is a paradox. It is highest when we forget it exists, and it is lowest when it's all we can think about."

And right now, it's clear that risk is the main thing on people's minds.

This being the case, wary investors seem eager to lock in fixed returns at a time in which the future returns of equities are more attractive than they have been in years.

It might be wise to question whether the decision to sell now (to lock in fixed returns) is likely to be prudent or foolish given a little time.

There's plenty of historical data to support the stay-the-course mentality. In a recent post, Ben Carlson shared that, since 1950, the average 5-year cumulative return following a decline of 25% from all-time highs is, get this…83.3%. And that's just the average which means some returns were much higher. But because I'm sure you're curious, the worst 5-year return was 21.5%.

Comparatively, the current 5-year Treasury rate is 4.35%. Over five years, that's a cumulative return of 21.8%, which is on par with the worst historical experience with equities.

With inflation still high, we should all ask ourselves, which is the riskier proposition from a real-return perspective: the asset with a likely return of 21.8% or the one with an average return of 83.3%?

As fearful souls panic and lock in suboptimal fixed returns (or stuff their money under the mattress), I expect that most of these folks will experience seller's remorse once they have the benefit of hindsight.

I remain emphatic about staying the course—or continuing to buy if you're in the accumulation phase—because the entirety of our investing lives has shown every bear market that has come before to be an obvious buying opportunity. Why would this one be any different?

That said, I understand it's uncomfortable because, during a bear market, it always feels like the higher probability is that the market will fall further. And that may be what happens. But we aren't investing for a period of days or months -- we are investing for decades.