Reframing investment risk

Reframing investment risk is one of the most powerful mental shifts an investor can make. In this video, behavioural finance expert Joe Wiggins explains why we often think about risk in unhelpful ways — and how to take a more productive view.

Risk is often equated with short-term volatility, market downturns, or sharp falls in value. But as Wiggins points out, this isn’t the kind of risk that really matters. If you’re investing in a globally diversified equity portfolio, it’s highly unlikely you’ll lose money over the long term.

The real risk, he argues, is falling short of your financial goals. That might be retiring later than planned, not affording the life you envisioned, or missing out on opportunities in the future. Seen that way, the occasional market correction isn’t a risk — it’s the price of admission.

By reframing investment risk to focus on long-term outcomes rather than day-to-day performance, investors are more likely to stay the course, ride out volatility, and earn the returns they need. Understanding this distinction is critical to long-term investment success — and it could stop you making costly emotional decisions during turbulent times.

Key takeaways

1. Investment risk is not about volatility

Market swings may feel uncomfortable, but the true investment risk is failing to meet your long-term goals, not short-term dips in value.

2. Equity returns come with behavioural costs

Higher returns from equities demand emotional resilience. Staying invested through downturns is what earns the reward.

3. Reframing risk helps long-term thinking

Short-term market pain can lead to better long-term outcomes, especially when valuations improve. Keep your focus on the big picture.

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Transcript

Robin Powell: There’s no getting round it: all investing involves risk, and equity investing in particular.

But is investment risk really something to be frightened of?

Joe Wiggins is an expert in behavioural finance. As Joe explains, it’s all about how risk is framed.

Joe Wiggins: So equities generally outstrip most asset classes over the long term, so therefore it seems slightly odd that you get a high return for doing that.

But you get that high return because there's a behavioral risk within equities that you have to go through day to day volatility, you have to go through, through bear markets. So there's a cost involved, a greater risk involved, a behavioral risk in generating those, those higher returns. So whenever we make a decision  that we hope to increase our returns with, we need to think about what are the costs, what are the negatives of doing this, and are we willing to, to, to bear them. 

There's no worse decision really than thinking, I want to generate a long run return from equities, but then you bail out at the first sign of volatility or, or drawdowns because you're not behaviorally disposed to doing that. So when we make these decisions, let's understand what the negatives or the potential behavioral implications are.

RP: In other words, it’s our ability to withstand short-term volatility that gives us long-term rewards.

If you have a globally diversified equity portfolio, it’s very unlikely, in the long run, that you’ll suffer a substantial loss of capital.

JW: The best way  I conceptualize investment risk is to think of it as not being about volatility or, or drawdowns, but about it being the, the chance that we fail to meet our long run outcomes.

So we've got certain objectives in the future, 10, years in the future. What are the chances that the decisions we make now with our investments mean that we fall short of meeting those objectives. So that can, that can reframe the.  So we're not thinking about the short term volatility investing in equities, but we're thinking about the chance that I won't be meeting the goals that I have for my future self in in 20 or 30 years time.

So risk is about failing to meet those goals.

RP: Volatility, corrections and bear markets can be painful. But they’re also inevitable.

The secret is to stay focused, when they happen, on your long-term goals.

JW: The key thing for considering poor short term performance is what are the implications for long run returns for our long run objectives?

So, for example, through 2022, we saw a significant rise in, in bond yields from incredibly low levels. And whilst that brings about short term pain, if we reframe it and think about the long term consequences of that, it means that we're now investing money into bonds that are offering  significantly higher returns than before, so that the valuations have improved.

Uh, and the chances of generating good returns from those bond investments over the long run have improved, so we need to think about it. Think about short term market movements in the context of what our long run objectives are.

RP: In short, don’t confuse risk with volatility.

The real risk, if you keep reacting to volatile markets, is that you’ll fail to generate the long-term returns you need.

© The Evidence-Based Investor MMXXV.