Am I ready to venture out?
Many of us have been home for more than 60 days. Most states are relaxing their stay-at-home guidelines, yet national health experts continue to warn us to be careful and keep our distance. The prospect of a second COVID-19 wave looms large.
The virus is expected to be around for months, if not longer. Yet, staying home indefinitely is not an option. The social and economic costs are great, but so are the risks associated with contracting COVID-19, especially since there is no vaccine and no proven treatment.
How do you strike the best balance between personal safety and social engagement? We are tired of being cooped up inside—tired of not living our normal lives. As restaurants, hair salons, and other businesses start to reopen more people are heading back out. You may be wondering, is it safe for me? Is the risk worth the reward?
Here at Wealth Enhancement Group, we understand risks and rewards; we grapple with them every day. We can apply what we have learned as wealth managers to shed light on how to decide the appropriate balance between personal safety and social engagement.
What Matters Most to You
It is always necessary to understand what is most important to you—even more so during a pandemic–when some choices we face are difficult and others are gut wrenching.
After being home for the last few months, it can be a difficult choice whether or not to dine at our favorite local restaurant or travel to see family who we have missed so much.
The gut wrenching choices occur when our value of personal health and safety conflicts with another one of our core values like social connection. Here are two illustrative examples:
James is 68 years old and has chronic heart disease. His daughter recently had her third child and is feeling totally overwhelmed. Her family has not been engaging in social distancing to the same degree as James. Should he take the health risk to travel and stay with his daughter’s family for a few weeks?
Ellen is 60 years old and lives with her 88 year-old mother. They have volunteered at a local food pantry for years. With record food insecurity, Ellen wants to help the food pantry deliver groceries to families in need. However, she is concerned about catching the virus and exposing her mom. Should she deliver the groceries or stay home with mom?
There is no clear “right” or “wrong” answer. When we are clear about what matters most to us, we will make choices we are less likely to regret.
Risk Capacity and Risk Tolerance
As wealth managers, we measure a client’s risk capacity and risk tolerance. Risk capacity is how much risk you can afford to take. Families with high monthly expenses and limited savings have a low risk capacity, so they are advised to keep their limited funds liquid in case they lose their job or have an unexpected expense. Families with substantial savings have a higher risk capacity, so they can afford to take more investment risk. If they suffer a loss, they still have plenty leftover to provide for their needs.
For COVID-19, risk capacity is about your age and health and the health of those you care about. People who are over 60—particularly those in their 70s and beyond—and have chronic health issues have a low COVID-19 risk capacity, so they cannot afford to take many risks. Those who are younger and in good health have a higher risk capacity, so they can afford to take more risks. Because COVID-19 is a communicable disease, we also must consider the risk capacity of those we care about.
Risk tolerance is about how much risk you are comfortable taking. For investors, risk tolerance is about your ability to tolerate losses in your portfolio.
COVID-19 risk tolerance is about your fear of contracting the virus. The less afraid you are, the more willing you are to expose yourself to potential virus carriers. Our COVID-19 risk tolerance may be high because we believe we are unlikely to fall seriously ill and die if we contract the virus. We may view the risk as nothing more than a bad case of the flu.
Risk capacity and risk tolerance work in concert to help us make decisions, but the two don’t necessarily correlate. Often, those with low investment risk capacity also have low risk tolerance. For those with a high investment risk capacity, risk tolerance can range from very low to very high.
In relation to COVID-19, many people with a low risk capacity (older, chronic health issues) are being very cautious. That is not true for everyone. There are some people with a low COVID risk capacity and a high COVID risk tolerance who are willing to risk exposure to the virus. Each of us must determine our own risk capacity and risk tolerance.
COVID-19 Risk Budget
Considering your risk capacity and risk tolerance, how willing are you to expose yourself to situations where you might catch the virus? This is your COVID-19 risk budget. Since our knowledge about the virus is rapidly changing, think about your COVID-19 risk budget in one month increments. Are you willing to expose yourself to an 80%, 50%, 10%, or 1% chance of catching the virus in the next 30 days?
The truth is, no matter how careful we are, all of us have some chance of contracting the virus. Your risk budget is how large you are willing to allow that risk to be. If you had a risk budget of 100%, you could do everything and anything because you would be totally comfortable with getting the virus. If you had a risk budget of 1%, you would not leave your home, you would not let anyone visit you, and you would let groceries sit in their bags for three days to let any virus on the boxes die before you touched them.
Additionally, it’s difficult to think about things like risk in terms of hard numbers. If you are willing to take a 20% chance of catching the virus in the next 30 days, it may be impossible to know how to equate 20% with certain activities. For example, if you choose to go to your favorite restaurant and eat outside, how much of your risk budget would you spend?
It might be easier to classify activities into low, medium, or high risk and to think of your risk budget as small, medium, or large. Those with small risk budgets should only engage in low risk activities. Those with moderate risk budgets might engage in low and moderate risk activities. Those with high risk budgets can engage in a wide range of activities.
We build portfolios to weather short-term market declines; we don’t want a temporary loss to become permanent. We often create a cushion of bonds and cash to allow clients to weather a protracted bear market without having to sell their stocks while they are down.
During this pandemic, the permanent loss we’re trying to mitigate is dying from the virus. The COVID-19 equivalent of cash and bonds is living a healthy lifestyle. Exercising, maintaining a healthy diet and reducing alcohol consumption can help reduce the risk of becoming severely ill if you contract the virus. Getting enough sleep can also help you fight the virus.
Small Risks Matter
As a wealth manager, we try to take small risks into account. After all, something that seems small can grow into a big win or a big loss over time. For instance, say we have two investors who each have $1,000,000 to invest. They both earn 8% gross of investment fees. The first one has internal expenses of 1%, and the second has internal expenses of 0.5%. After 20 years, the first investor’s $1,000,000 has grown to $3,869,684. The second investor’s $1,000,000 has grown to $4,247,851. With just a difference of 0.5% between investment fees, the second investor has accrued an additional $378,167—or almost an additional 10%.
In the time of COVID-19, many of us are leaving our homes, and we may be thinking it is okay to take a small risk of contracting the virus. The challenge with this line of thinking is that taking repeated small risks will compound—like the $1,000,000 in our example. If you took a one in 1,000 chance of contracting the virus each day for 100 consecutive days, your chances of getting sick would be a little less than 10%. If you double the risk to two out of 1,000, the chance of getting sick rises to about 18%. If the risk rises to five out of 1,000, the chance of getting sick over the 100 days rises to about 40%.
One, two, or five out of 1,000 is not very much, but it can add up. When you can, avoid small risks that don’t help move you towards your goal. Over 100 days, your risk will drop from 40% to 10% if you drop your daily risk profile from 5/1,000 to 1/1,000.
Putting It All Together
All choices have costs and benefits. We see it with our financial choices, our personal choices, and today with COVID-19. There is no right answer to how much we venture out of our homes during this pandemic. There is only the right answer for each of us.
As you make this decision for yourself, consider what matters most to you. Assess your risk capacity and risk tolerance to determine your COVID-19 risk budget. Don’t waste your risk budget, remember that small risks matter, and live a healthy lifestyle to mitigate the effects in the event that you get sick.
Stay healthy. Stay strong.
CFP® David joined Wealth Enhancement Group through the partnership with JOYN Advisors, where he acted as CEO and Co-Founder. He is the creator of the Behavioral Wealth Management™ model. A model that focuses on aligning wealth management with the integration of human emotions while taking into consideration an individual’s talents, wisdom, network and relationships. David has been featured in a number of prominent outlets including The New York Times, The Wall Street Journal and The...Read More