FFR 283 – Understanding Risk

Risk in investing isn’t always where it appears to be. Some of the calmest markets can carry the most danger, while the most volatile moments can create real opportunity. The role of leverage—both in portfolios and within companies—often goes unnoticed until it matters most. Understanding where risk is building, and where it’s actually declining, can make all the difference when markets shift. If you want some insight into how Stiles Financial thinks about portfolio risk, click to watch Episode #283.

As always, we’re happy to discuss how these ideas may apply to your situation.

FFR # 283 – What Most Investors Miss About Risk.

Welcome to this week’s Financial Flash. So, volatility is back in the market.  We knew it would happen, but predicting when is extremely difficult.  This week, I’m going to talk a little bit about how the Stiles team thinks about portfolio risk.

When most people think about risk in investing, they think about volatility—markets moving up and down, sometimes sharply, sometimes unpredictably.

Risk is not constant. It changes depending on valuation… and it changes even more when leverage is involved.

Volatility is the price of admission in markets. It’s normal. It’s unavoidable. Prices move because expectations change—about earnings, interest rates, or the broader economy.

But volatility alone doesn’t cause losses. Valuation matters too.

When valuations are low, volatility can actually be your ally. You’re buying assets with a margin of safety. Expectations are muted. Even if prices swing in the short term, the downside is often limited, and long-term returns tend to be more favorable.

But when valuations are high, volatility becomes far more dangerous.

There’s little room for disappointment. When reality doesn’t meet expectations, markets don’t just fluctuate—they reprice.  This often results in a correction or even a bear market.

Now let me layer in something I’ve experienced firsthand—leverage.

Earlier in my career, I worked as a hedge fund trader, managing portfolios that used leverage.

Leverage amplifies gains, but it also magnifies losses. And more importantly, it takes away your ability to be patient.

Forced selling into fast moving markets with low liquidity is not for the faint of heart.

And that’s when John Maynard Keynes’ warning becomes very real:

“The market can remain irrational longer than an investor can remain solvent.”

You might be right on valuation. You might be right on fundamentals. But if you’re levered, timing suddenly matters more than it should—and volatility can push you out before you’re proven right.

Now, at Stiles Financial, we don’t use portfolio leverage.

But that doesn’t mean we’re immune to its effects.

When others are forced to unwind leveraged positions, it creates selling pressure across the market. Prices fall—not always because fundamentals changed, but because liquidity is being pulled out of the market.

And even well-constructed, unlevered portfolios feel that impact.

So leverage doesn’t just increase risk for the investor using it—it increases volatility for everyone.

But leverage also exists at the corporate level—and this is just as important.

Companies with conservative balance sheets—low debt, strong cash flow, and access to credit—have a major advantage during periods of stress.

When volatility rises and markets sell off, those companies can actually go on offense.

They can borrow when others can’t.  Issuing debt to buy back their own stock at depressed prices is a strategy used to turn volatility into opportunity.

On the other hand, highly levered companies don’t have that flexibility.

They’re sometimes focused on survival, not opportunity.

They cut back, retrench, and in some cases face real distress.

Now let’s zoom out.

Periods of low volatility often coincide with high valuations and increasing leverage—both at the investor level and the corporate level. Confidence builds. Risk feels low. People stretch.

But that’s often when risk is actually at its highest—just beneath the surface.

Then volatility returns. Prices fall. Liquidity tightens. And leverage begins to unwind.

And when both reverse at the same time, the downside can be fast—and unforgiving.

So here are the takeaways:

Volatility is inevitable. You can’t avoid it.

But risk is shaped by two things you can control:

The price you pay… and the leverage you take—both directly and indirectly through the companies you own.

So instead of asking, “How volatile is the market?” ask:

Am I paying a price that gives me a margin of safety?

And am I positioned to withstand—and even take advantage of—the volatility that others may not be willing to endure?

As part of the investment team here at Stiles, these two questions are what drives the investment decisions that we make on behalf of our clients.  The answers to these questions are not the same for every client, so not every client portfolio looks the same.

In closing, those who respect valuation, manage leverage, and prioritize strength over stretch put themselves in a position not just to endure volatility…

…but to benefit from it.

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Have a great weekend and we’ll see you in the next Financial Flash.