Rethinking Risk: Ignore Percentages to Focus On Aligning Assets & Goals
4/10/2022 6:37:00 PM
Risk can be confusing – especially when it comes to your investments.
As an investor, you may be accustomed to thinking about risk in terms of how much your portfolio’s market value bounces around. You might see the stock market drop deep into the red and worry about what that means for your portfolio.
Risk can be defined and measured in a number of ways; traditionally, an investor’s risk tolerance and risk capacity were the main factors that drove creating your investment portfolio’s asset allocation strategy (mix of stocks and bonds). What can be problematic with this method is risk tolerance is subjective.
When markets rise, investors tend to be more “risk on.” When they fall, investors tend toward “risk off.” These movements typically are made with emotion – disregarding your goals and how you plan to use your future net worth. This is why a better approach may be rethinking risk and considering your assets as a means to accomplish a life’s worth of goals.
We understand goals can seem like a buzzword used as a catalyst to make a financial plan, but there’s a good reason for that. Goals are crucial and deserve the time spent to carefully reflect and identify them.
How much do goals actually influence how your portfolio is allocated?If you truly intend to think about your net worth as a tool to help you accomplish a life’s worth of goals, then you need to understand that simply identifying those goals is only the first step. Goal-setting should be specific and include both the timing and financial impact of the goal. Once a set of goals has been established, a method called glide path investing can be used to determine the asset allocation strategy that matches each goal.
A glide path approach to asset allocation mimics another portfolio management technique called asset/liability matching. The concept is simple: invest in a manner that aligns certain assets with certain future liabilities.
- Each goal is assigned an asset allocation based on the amount of time until the goal needs to be achieved.
- Long-term goals are assigned a more “risk on” allocation, while near-term goals are assigned a more “risk off” allocation.
- Repeating this process for each goal results in an overall asset allocation strategy more purely aligned with your goals.
- Since each allocation depends in part upon the time until the goal is funded, each goal’s allocation is adjusted as time passes to reduce the amount of risk associated with funding that goal.
Risk should be measured in how likely you are to fund your goals – not in the volatility of your investments.
Using a glide path approach is not the be-all and end-all of investing. It does not take into account your tolerance or capacity for risk, which you do need to consider. Additionally, simply creating an asset allocation does not mean you have sufficient assets to fund all of your goals. You’ll need to compare your current level of net worth, capital market assumptions and other factors such as inflation, taxes and fees in order to determine the probability you will achieve the financial goals you’ve set.
At Bell Bank Wealth Management, we will show you what opportunities your wealth opens up for you. Our process helps you invest with intention and the confidence that you are well-positioned for your future.
SVP/Senior Wealth Management Advisor
Products and services offered through Bell Bank Wealth Management are: Not FDIC Insured | No Bank Guarantee | May Lose Value | Not a Deposit | Not Insured by Any Federal Government Agency
This article has been written for the general information of clients and friends of Bell Bank. It is not intended, nor may it be relied upon, as tax or legal advice with respect to any matter. This article also cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by the Internal Revenue Service or other taxing authority.