When I meet people at conferences, typically the first question I am asked is “Rob, how much precious metals should I own?”. It is a great question! Because I am not a financial advisor, I cannot make direct financial recommendations.
But what I can do is discuss basic considerations you should be making BEFORE you buy, so that you can do your own due diligence and make decisions that are best for you. And then we can discuss what different allocations (percentages or amounts) look like in a sample portfolio if we want to try and build a basic strategy (hint: last step after risks are identified).
Most people buy investments and then try to determine risk. That is not good, in my opinion, because it puts the cart before the horse. Risks should be known first.
This will be the first in a small series of articles related to managing portfolio risk. The articles will make no specific investment recommendations; rather, they will elaborate on the process many businesses and individuals use to manage risk in their investment and savings portfolios.
Understanding Risk Management
I spent many years in corporate America in risk management-type positions. Meaning, we had to assess the risk of a given course of action or result of operations and report to management. There are many ways to look at risk, and in fact, there are accepted best practices when it comes to risk management. For example, one of my Master level courses in information security was titled Risk Management.
The class was taught by a Chief Audit Executive (CAE) who had also spent many years as a security risk executive, long before the title of Chief Information Security Officer (CISO) was created and began to be used by the industry. Now, most companies have both roles defined and it is quite the exception when large corporations do not employ entire teams of security and audit personnel.
Why? Well, companies operate on a risk management basis to make decisions as to how to mitigate (reduce) the risk of everyday operations. Risk can come in many forms, and in fact, most executives such as CEO’s make decisions mostly on the perceived or potential risk of different courses of action.
That is because no company can eliminate all risks. And, neither can we! Sometimes we must accept risk in our investment portfolios because the risk is the flip side of the coin to reward, known as investment gains in our example of considering precious metals in our portfolio.
Per Investopedia:
“Effective risk management plays a crucial role in any company’s pursuit of financial stability and superior performance. The adoption of a risk management framework that embeds best practices into the firm’s risk culture can be the cornerstone of an organization’s financial future.”
So, if the big companies use this to manage their everyday risks, why can’t we adopt a similar view on managing the risk of our portfolios? The great news is that we can! We just need to have a basic process to use in assessing risk, which is what we discuss next. And trust me, it is not nearly as complicated or intimidating as it may sound at first glance. I will make sure that the principles are easy to understand and apply should you wish to utilize them.
Step 1: Risk Identification
Step 1 is very obviously important because without identifying the domain of potential risks we face; it becomes very difficult to build a portfolio of precious metals (and other investments) that will address our true needs while mitigating the downsides and potential losses.
Warren Buffet, one of the greatest investors of our time, has a famous saying about losses. “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” I believe those are famous words to live by. But to know how to keep our money, we must limit our risks and the first step to doing that is identifying what those are.
I consider Step 1 to be the most important, because if we cannot identify a risk, then we cannot mitigate it. Unidentified risks are the single biggest danger to the performance of a business or portfolio. Therefore, the entire first article in this series will be about Step 1 of the 5 in our risk management framework (RMF).
Again, it sounds all sorts of complicated, but trust me it really is not. After you do this the first time, it will become second nature. Further, you are likely to unconsciously apply this process to other aspects of your life without even knowing it.
Creating a Risk List
Risks should be identified, even loosely, in written form so you don’t forget them. This is formally called a risk register, but in our case, we just call it a risk list to keep it as simple as possible.
What that risk list looks like is up to you. In the corporate world, much time and effort are put into identifying risks. True, various industry groups will publish their own versions of a risk list that can guide professionals in space. But what we really want is something easy to apply.
The risk list should be personal to you because this is your investment portfolio. Generally, a list will start with a brainstorming (open and unencumbered thought) session where all possible risks are identified and put on paper. I use an Excel spreadsheet because I am extra geeky like that. Or you can just write them down on paper if you want to.
Writing them down for later review is generally more beneficial in the long run. After all, you are going to use the list more than once in your lifetime and likely every time you review your investments.
Can You Get Me Started?
Typically, from an investment perspective, we want to identify counterparty risk first. That means anybody else who could affect your investment is considered a counterparty. For stocks, it could be market events, the company itself, how and where your stock is held, the number of other investors involved in the market, and whether it is in a qualified investment or after-tax investment, etc.
Gold and silver have no true counterparty risks in their physical form, other than the risk that the paper derivative markets (COMEX in the US) are used to determine ‘spot’ prices which we all use as the base price for buying metals. As outlined in previous articles on the blog, the premium is simply the markup on metals that occurs after they are sourced from the COMEX and then processed, remelted, and passed from wholesalers to retailers. Spot + premium = retail metals price.
That is a starting point, but I really want you to do your own brainstorming session and write down your own list. Because after all, investing is very personal and should be catered to your own level of risk tolerance (more on that in a later article).
Final Thoughts
Identifying risks is the first step in developing an investment portfolio approach. We have 4 more steps, and the good news is they get easier once the first step is done. And it doesn’t take nearly as long as you think. A couple of hours’ work total gets you a much better understanding of your personal needs for investment and the potential risks involved.
Further, what that time commitment does is arm you with a lot of information that will guide your investment decisions while limiting your losses. After all, the first time you lose money on an investment, you will likely be motivated NOT to make that mistake again.
And THAT is the essence of risk management. It’s not nearly as hard as it sounds, but the benefits can be tremendous and can help you sleep much better at night. And in my opinion, that is worth the time and effort all by itself.
Rob Kientz is a precious metals industry expert with over twenty years of investment experience in bond, stock, real estate, commodities, Forex, and precious metals markets.
