Many things in this world cannot be explained: how you put a pair of socks in the dryer and only one comes out, Déjà vu, Bigfoot, how the mind and body connect, and even how much risk you are taking in your investments. But wait, that last one is not as mysterious as your broker or advisor may want you to believe!
Investments may seem like a very complex form of gambling with the ability to purchase stocks, bonds, options, futures, and even the ability to “speculate” on what the price of pork bellies will be in the coming year. Well one thing is for certain, there is a specific amount of risk with regard to investments. What you need to know though is that when investment people talk about risk, what they are really saying is that there is a certain amount of volatility, or ups and downs, that you can expect from your investments. This is a specific number that statisticians call Standard Deviation.
I know, you may say, “I am no mathematician, and numbers scare me!” Don’t worry; it is not as complicated as you may think. When you purchase an investment, the price of that investment goes up and down every single day, as well as every week, month and year. I know it’s a shocking statement! What a statistician does is take the entire daily returns for a specific period of time, for example one year, add them all up, and then divide by the number of days. If you remember your math classes, this will give you an average or the mean.
Although I will not go into how to calculate the standard deviation number, what that number tells you is how much you can expect your returns to be up or down (deviate) from the average. For example, over the last 37 years US Treasury Bills have returned an average of 5.76% per year. The standard deviation for that investment is 3.10. So if we use our basic math skills, what we can expect a range on any given year between 2.66% and 8.86%. Most of the time you can actually find a standard deviation for each investment you own by going to financial websites, but you can imagine how complicated it can get if you have quite a few investments.
What a financial coach does is help to teach you how to find your current number and help to determine whether you are receiving the expected return for the given level of risk you are taking. If you are not sure what your number is, or how important it is to your financial future then give us a call or send us an email. We would love to help educate you regarding these issues.
Philip A. Guske