How Much Can Your Clients Afford to Lose?

As if on cue, a mostly unrewarding investing year came to a close along with the entrance of a new book called Risk Less and Prosper by Boston University professor Zvi Bodie and financial advisor Rachelle Taqqu. In an interview with AdvisorOne, Bodie argued that "you shouldn't think you're going to earn a potential risk premium without taking risk. It was always a crazy idea to think that you could, but that idea was drilled into people's heads by a whole industry campaign." He and Taqqu are trying to revive the old-fashioned idea that investors start by covering their basic needs first and then look at worst-case scenarios before putting their savings at risk.

Nobel Prize winning economist Robert Merton, in his foreword to the new book, suggests a role here for financial advisors: "Households have been left with the responsibility for making important and technically complex microfinancial decisions involving risk — decisions that they did not have to make in the past, they are not trained to make in the present, and they are not likely to execute efficiently in the future, even with attempts at education." 

Ordinary investors need not feel underprivileged for lack of access to more exclusive investment opportunities. And poor recent equity returns and record-setting daily volatility are fresh reminders that the dream of triple-digit returns comes at a cost that most investors can ill afford.