How you view risk vs. opportunity has a lot to do with how you live your life and manage your money. And even if you consider yourself an optimist, you might be too pessimistic in your expectations for the future.
Bob Veres, a financial advisor industry analyst and writer, referenced this thinking in a recent column about Dennis Stearns. Stearns is a financial advisor in North Carolina who wants to help people see risk and opportunity differently. In addition to his work advising clients, Stearns is an expert on scenario planning. Scenario planning is a process used by large companies to explore different possible futures so they can prepare for events, both probable and improbable.
After a lot of analysis and forecasting, Stearns thinks that planning for the future should “be thought of as 25% risks and 75% opportunities.”
Stearns thinks people generally see the world and their future with the opposite view – 75% risk and 25% opportunity. “The problem,” Stearns says, “is that the 25% threat is magnified by the 24/7 media to the point where everyone believes that it is actually the 75%.”
Media overweight bad outcomes because fear attracts readers, watchers and re-tweeters. Fear sells.
This creates an opportunity cost when people aren’t positioned to take advantage of innovation, improvements in quality of life and investment possibilities. Some people miss opportunity entirely while viewing the world with a risk-first lens. Others are just late identify and utilize opportunity.
An example of the 75% risk/25% opportunity mentality is what has happened to longer-term interest rates in the U.S. over the past four months.
Over the past five years the U.S. Federal Reserve has kept short-term interest rates very low to encourage the growth of our economy. Since December 2008, the Fed also attempted to jump start the economy by buying government bonds on the open market:
- From December 2008 until March 2010, the U.S. Federal Reserve purchased over $1 trillion of agency mortgage-backed securities and Treasury securities.
- In November 2010, the Fed announced a second program to purchase $600 billion of long-term U.S. Treasury securities. This was undertaken at the rate of $75 billion per month.
- In September 2012 the Federal Reserve announced that it planned to purchase $40 billion of agency mortgage-backed securities per month as well as $45 billion of long-term U.S. Treasury securities. These purchases were promised to continue until the U.S. unemployment rate improved “substantially.”
Together these actions kept the longer Treasury bond rates down until a few months ago.
Why is this? Over the past few months investors have become scared that two separate events, the ending of this QE program and increases in the short-term interest rates set by the Federal Reserve, are both going to happen together. When Federal Reserve chairman Ben Bernanke announced that there is the possibility that this quantitative easing program would be slowing down or ending, financial journalists and investors all lept to the same conclusion. If QE 3 is ending, that means that U.S short-term interest rates have to go up. Bernanke said nothing of the sort, but investors looked at this information through their “risk” lens and drove up rates in the marketplace without any action from the Fed.
At the beginning of May, the yield on a 10-year Treasury Bond was 1.64%. On August 22, it hit a recent peak at 2.90%. That’s an increase of 76.8% in less than four months. Imagine if the S&P 500 jumped like that. A large reason for this change was because the market has become convinced that both the tapering down of QE 3 and the increase in the Federal Funds rate are linked.
We don’t think they are. We think that the market has overreacted to this risk. Bond investors have focused 75% of their attention on the risk and 25% on opportunity.
We like Stearns’ insight and encourage our clients to think more with an abundance mentality than a scarcity mentality. For as much uncertainty and negativity as there is in news, politics and finances, we think people tend to underweight the great power of advancing society and innovation.
And especially with investment management, the point of maximum anxiety tends to present the moment of greatest opportunity.
Having the insight to recognize it is certainly one of the tenets of great investors and something we hope to help our clients act on.
~ Brooks, Hughes & Jones – Partners in Wealth Management – Tacoma, WA