In the midst of all the research and analysis put forth by virtually every entity within the financial services industry, I VERY rarely see any mention of what I deem to be the two greatest risks that individual investors face each and every day.
We are fed and can read volumes about a wide array of risks, including market risk, interest rate risk, credit risk, currency risk, prepayment risk, volatility risk, and liquidity risk. While overwhelmed by analysis on these risks my ‘sense on cents‘ leads me to focus primarily on the two greatest risks of all.
What are these risks and why is it that those within the financial services industry do not highlight them?
1. Greatest Risk of all is REPUTATION RISK!! Whether for individuals, small businesses, large corporations, or any other entity, the chance of developing and dealing with a tarnished reputation is the greatest risk by far in our marketplace. Just ask Penn State.
Wall Street broadly speaking will spend endless amounts of dollars and time in fending off the stench and degradation of a tarnished reputation. These dollars are directed toward Washington and marketing for purposes of influencing legislation and regulation that would otherwise protect investors. That said, Americans are just now beginning to appreciate the fact that reputation risk has been mispriced egregiously for a protracted period. The declining trading volumes across most market segments are an indication that reputation risk is being repriced.
1A. The next greatest risk and a close cousin to reputation risk is counterparty credit risk. This risk has also been massively mispriced for an extended period. Counterparty credit risk addresses the ability of the entity with whom you engage to perform and deliver on their obligations. How often have you received any information from brokers, money managers, financial planners, or other intermediaries with whom you interact on this risk? I am guessing not all that often.
Counterparty credit risk goes straight to confidence. Do you think shareholders, creditors, and customers of Lehman Brothers, Madoff, Stanford Financial, MF Global, AIG, et al wished that they had properly understood and addressed this counterparty credit risk in the midst of doing business with these firms? You think? Again the industry works hard at disguising and mispricing this risk.
What are investors to do in the face of these greatest of risks?
Be exceptionally careful and inquisitive in understanding the individuals and firms whom you engage, or in other words as Sense on Cents is wont to say….