My Concepts of Risk and Return

Figuring out how much investment risk and return you can expect is a tricky equation. I’ve gotten that question so many times in my 30 plus years, I can’t remember them all. And the truth is, I’ve seen many do-it-yourself portfolios unravel because of emotional overconfidence or panic. For people in the mass-affluent bracket — folks say, between 2 million to 5 million dollars — understanding risk isn’t easy to do, unassisted. My advice today? Setting out lifetime financial goals is an early part of working with any financial professional. Investment managers help you. They help you select those funds and securities that can work for you. But only after we know where you want to go financially, and when you expect to get there.

Measuring portfolio risk is one thing — it’s quantifiable. But how do you measure your individual, gut-level risk tolerance? Not so easy. In fact, it’s as much art as science. That includes provisions for major, sometimes unexpected, changes in your life. A sound risk profile won’t sweat today’s unrest in the Stock Market; but instead, it prepares you for the financial impact of a new baby, or funding a child’s college tuition… or retirement, or caring for aging parents… or providing for your own long-term health-care needs. Expecting the unexpected is also wise: Big changes such as divorce, the sudden loss of a job or a serious illness can all disrupt a carefully considered investment plan. So again, whenever planning for the reward, plan for your personal—and many times unexpected—risk.

Excessive caution and excessive optimism are common stumbling blocks for investors who’ve upped the level of service and attention by hiring a money manager. People in the financial-services industry now refer to them as wealth managers. While there’s no universal asset-allocation model, I’ve heard people say to subtract your age from 100. That number, let’s say it’s 40, can be a decent starting point for figuring out your percentage split between stocks and bonds. So 40 percent bonds, 60 percent stocks. The younger you are, the more your portfolio can benefit from higher-risk equity investments; the closer you are to retirement, the smarter it is to tilt toward steady, fixed-income investments. But again, everyone is different. And I don’t totally dig that cut-and-dried subtraction equation I just mentioned, so you know. It might be a starting point for discussion sake, but never an ending point. That’s where your personal risk comes in.

As the average lifespan in this country grows, expectations about how you’ll spend your money may have to change. An annual withdrawal rate of more than 5% for a portfolio in the mass affluent bracket likely won’t be sustainable for someone who lives well into their 80s. And the mass-affluent-type investors often need the most help. Why? They have a much higher standard of living which has become an expectation. It’s often harder to meet than many investors anticipate. For many, they not only want to be advised, they really need to be advised. If you look at future income replacement guides or run some calculations (like we do in my office) there’s not really a whole lot of wiggle room for error. So keep that in mind. And risk plays in to the equation. Because if your money is aggressively bouncing around 5 to 10 percent every quarter, that might not make you feel comfortable, you know?

Risk tolerance touches on many home truths of investing. It’s really at the crux of what I’ve done my entire professional live. But unfortunately for most investors, these lessons often come learned the hard way. It’s common to experience emotional ups and downs about your hopes for the future, getting a grasp on the financial underpinnings of how you live your life… et cetera, et cetera. And that’s no different for the people who you hire to manage your money. Their job is not to just help you meet your financial goals, but help you manage your risk tolerances. And for most investor’s those tolerances have been quite taxing in recent years. Remember: plan for the unexpected. While that’s not always easy to do, financially it’s pretty intelligent. And it’s core strategy to wealth preservation and wealth protection that will never go out of style.