Risk Management

……In Our Continuing Series “Am I Prepared?”

The past several years have been trying for many people planning for or entering retirement. The volatility of the financial markets has created angst and fear as people have watched the value of their capital fluctuate. Additionally, many peoples’ portfolios have not recovered fully from the 08-09 bear market. What these conditions have really driven home is the element of risk in investing, in this case, downside volatility. The great bull market of 1980s and 1990s created an environment in which risk was all but forgotten or downplayed. The focus then was a pro-risk, gain or greed environment, typical of bull market psychology. Now the focus is on risk avoidance driven out of fear of capital loss.

What is risk ?

Most of us would consider “risk” in the context of potential for downside or loss, in this case capital. There are a numerous factors that contribute to risk in investing, not all of which can be easily quantified. Some of the more common “macro” risks include economic risk, geopolitical risk, country risk or industry sector risks, interest rate risk, currency risk, inflation/deflation risk, valuation risk, etc. On a more “micro” level, some of the more common risks include company-specific risks or portfolio exposure risks. All of these factors create volatility in the markets.  

How do we deal with risk ?

 As financial planners, one of our most important responsibilities to our clients is to properly assess and manage risk in their investment portfolios. We do this by taking time to understand clients’ needs, goals, and lifestyle preferences, and carefully assessing their attitude and tolerance towards risk. This has an important bearing on the allocation of the assets in their portfolios which, in turn has an important impact on portfolio volatility (or risk).

Other ways in which we assess and address risk include: diligence in studying and understanding the overall market environment and the economic factors driving the markets; portfolio diversification; reducing exposure to company-specific risk through the use of index and/or exchange traded funds; portfolio hedging; and developing a sound financial plan. As we’ve said before, a sound plan helps to keep a client’s investments on course to achieve long term goals and reduces the risk of buying or selling at exactly the wrong time (otherwise known as “human emotions” risk).

Risk is part of investing, there is no way to get around this (even bank CDs have risk, albeit small). And there are always going to be major events and surprises that none of us can predict. In the end, the best way to mitigate risk is through proper portfolio allocation, understanding your risk tolerance, understanding and accepting what you don’t know, having a plan and sticking with it, and working with a professional you trust. By the way, you might want to ask your financial advisor how he/she is managing risk in your portfolio and have him explain it in a way that you understand and that makes sense to you.