The Biggest Risk

March 19, 2024

I wonder what the airmen who awoke at Pearl Harbor that fateful December morning in 1941 thought was the biggest risk in their lives. A freak accident while they endured their training for the day, perhaps. I am almost certain not a single one woke up thinking about the risk of a Japanese bombing raid. But by 9am that morning, zero servicemen had perished while training. 2,403 were killed by a risk no one saw coming.

The finance industry spends considerable time thinking about risk. Analysts and algorithms incessantly analyze and quantify it. Wall Street has made untold billions dividing, packaging, repackaging, marketing, buying, and selling risk. Sometimes it does so prudently to the benefit of society. Banks are more willing to underwrite your mortgage when they know Wall Street will buy it. Other times greed overtakes prudence. Banks underwrite mortgages for people with no job or income because they know Wall Street will buy them. Wall Street, in turn, knows (knew?) it can package it with a thousand other similar loans and fool regulators into rating it AAA because it’s “diversified” and resell it (there’s the ’08 Great Financial Crisis in two sentences). Almost every decision in finance comes down to evaluating, managing, buying and/or selling risk.

So anyone managing money should be considering the biggest risk.

But the biggest risk is the one no one sees coming.[i]

Pearl Harbor, COVID, the Great Depression, and 9/11 all share two characteristics:

  • They were massive, world-changing (and market-moving) events.
  • No one saw them coming.

People get swept up in bull markets. They want to own the latest asset minting generational wealth. A few centuries ago it was tulips. A few decades ago it was dotcom stocks and Florida real estate. A few years ago it was crypto and meme stocks. Last year it was Magnificent Seven stocks. This year it’s anything tangentially tied to “A.I.,” Nvidia is the posterchild. Bitcoin is making a comeback too. Chasing the hot asset can be profitable in the short term, but history is littered with assets nearly reaching the moon before being sucked into a black hole. If an asset soars it can plummet twice as fast. Chasing the asset du jour leaves you vulnerable to the biggest risk – the risk no one sees coming. The tricky thing is it can take a long time for that risk to materialize. It is by definition both unquantifiable and indescribable. It is the easiest risk to ignore.

Investors are often overzealous comparing their portfolios to the latest hot asset or to equity benchmarks. The S&P was up 26% last year, the NASDAQ was up 55% and NVDA was up 239%. My portfolio is only up 20% - what are we doing here?! There are two simple explanations. The first is your advisory team doesn’t know what they are doing. We have seen portfolios where this is sadly the case. The second is they are prudently managing risk. Particularly the biggest risk. The one neither you, they, nor anyone else sees coming. If your advisors know what they’re doing, your portfolio ought to be more robust to the biggest risk (that does not mean it won’t decline in value! Just likely not as much as whatever concentrated asset shooting the lights out presently may), which likely means lower returns in the meantime.

Investors in Japan experienced this a few decades ago. The Japanese stock market (the Nikkei) rocketed from 6,867 to 38,915 over the course of the 1980s. By 1990, Japanese stocks accounted for 45% of the global stock market (U.S. stocks made up 33%).[ii] Portfolio outperformance seemed merely a function of one’s exposure to Japanese stocks. Japan was ostensibly poised to become the economic powerhouse of the world. Then the biggest risk materialized in 1990 when overleverage popped the Japanese stock market bubble and poor demographics kept it deflated. You may have seen something about Japanese stocks in the news lately – the Nikkei finally hit an all time high again in February of this year. It had been in a drawdown since 1989. No Japanese investor saw the spectre of a 35-year bear market on the horizon. But that was the biggest risk.

The biggest risk can invert quickly. In December of 2019, the biggest risk was government-induced economic shutdowns on a global scale, which no one was thinking about. At that time “Wuhan” wasn’t yet in the vernacular. In fact, if someone mentioned something along the lines of “government-induced global economic shutdown” you would have thought they were discussing some dystopian novel. Yet, by March of 2020 the S&P 500 was down 34%.[iii] No one saw that coming a few months previously. Then the biggest risk suddenly inverted. While everyone was panicking about a virus and hollering about black swans while watching the market shed one third of its value at the fastest pace in history, the biggest risk shifted to the upside. The following 50 days the S&P 500 returned +37.11%,[iv]the greatest 50-day rally in stock market history. The biggest risk in February was being in the markets when the idea of a government induced economic shutdown was formulated. The biggest risk in March was being out of the markets when a government induced economic shutdown was implemented.

(Since the 2020 COVID stock market crash is still in recent memory, I feel obligated to mention the S&P 500 has returned +145.3% (+25.23% annualized) since the bottom on March 23, 2020).[v]

Carl Richards says risk is what’s left over after you’ve thought of everything. Recognizing you can’t think of everything requires humility, and humility in investing is boring. It is embracing diversification and eschewing leverage, overconcentration, marketing timing, and speculation. It is avoiding behaviors that can wipe you out when the biggest risk – the one no one sees coming – materializes.

One of my favorite activities is watching my 16-month-old daughter at the park. Unblemished, carefree joy running from the slide to the swing. The big smile on her face as she climbs the jungle gym. She doesn’t know about the biggest risks in her life. Cancer, car accidents, war, political strife, murder. She is completely unaware. Ignorance really is bliss. We, as investors, are a bit like my little girl playing at the park. Completely unaware of the biggest risk. Right up until the moment it rears its ugly head. We should have some humility when building and measuring our portfolios.

The price of increased robustness to the biggest risk is often some measure of “underperformance” during the good times when the biggest risk lies dormant.

We believe it is a price worth paying.

Sean Cawley, CFP®

Neither asset allocation nor diversification guarantee against investment loss. All investments and investment strategies involve risk, including loss of principal.

Content here is for illustrative and educational purposes only. It is not legal, tax, or individualized financial advice; nor is it a recommendation to buy, sell, or hold any specific security, or engage in any specific trading strategy. Results will vary. Past performance is no indication of future results or success. Market conditions change continuously.

This commentary reflects the personal opinions, viewpoints, and analyses of Resolute Wealth Management. It does not necessarily represent those of RFG Advisory, clients, or employees. This commentary should be regarded as a description of advisory services provided by Resolute Wealth Management or RFG Advisory, or performance returns of any client. The views reflected in the commentary are subject to change at any time without notice.

[i] I first came across this concept in Morgan Housel’s work. I believe he is the first to articulate it, although I am not certain.


[iii] YCharts, Fundamental Charts, ^SPX Total Return Level, 02/19/2020 – 03/23/2020.

[iv] YCharts, Fundamental Charts, ^SPX Total Return Level, 03/23/2020 – 06/01/2020.  

[v] YCharts, Fundamental Charts, ^SPX Total Return Level, 03/23/2020 – 03/18/2024.