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Investing is All About Managing Risk :: Retirement Success :: THE RETIREMENT SOURCE®
Investing is All About Managing Risk

Manage Investment Risk

Investing is all about managing risk. Real risk, that is. Many sophisticated investment people define it in terms of alpha, beta, sigma and lots of other Greek letters and mathematical notations. These sound important, but real people know that real risk is not about random market fluctuations. It is about two very important things: the permanent, irrecoverable loss of your money and the inability to get the cash you need when you need it.

Based on our Chief Strategist’s perspective of more than 50 years in investment research, we are convinced that investing is essentially about three things in this order of importance:

  • Cash
  • Risk
  • Taxes

The most important aspect of investing for any purpose, the TIME HORIZON, consists of these two vitally important factors.

# 1 The cash flow factor is the first and most overlooked area of investment planning. If a person is adding to investment accounts on a regular basis and has no foreseeable need to take any money out, this greatly lengthens the potential holding period (and tolerance for fluctuation) for all investments. If, on the other hand, the investor is making regular withdrawals for lifestyle needs, this makes for a much shorter time horizon. The drawdown of cash from the portfolio when values are down may make it difficult or impossible to recover and create a downward spiral.

# 2 The second aspect is the risk factor. This is made up of two equally important parts. The first is the longevity; that is the time period over which investments must serve the owner’s needs. For example, a person age 50 may well live, and need to draw on investments, for another 40 to 50 years. One of our greatest fears is that we might run out of money during our lifetime. The second is personal risk tolerance, which is a person’s psychological readiness to handle risk. It is important to understand that risk is a very personal concept and is the most changeable item for most people. There is a great tendency to underrate one’s risk tolerance when everything looks bleak and to over-estimate it when everything looks rosy. Too many people foolishly focus on short-term results and lose sight of their true time horizon and why they are investing.

After time horizon, the next important issue is the tax position of your money. This is one of the most under-appreciated aspects of investing. Many investors fail to take into account the impact of income taxes on their net rates of return and of estate taxes on their ability to pass assets on to heirs. By carefully selecting appropriate investments to place in each type of account (taxable, non-taxable or tax-deferred), you can improve your probabilities of achieving a higher after-tax return and making your money last.

Remember, it’s not what you make; it’s WHAT YOU KEEP - Net4.  That is, what’s left after all costs, expenses, market loss, income taxes, estate taxes and inflation.

The goal of retirement investing should not be to try to make as much money as you can. Since there is a trade-off between risk and reward, that approach is almost always self-destructive. More appropriately, investors should seek to build a tax-efficient portfolio that has a strong probability of meeting their target rate of return at the lowest total risk acceptable according to their time horizon.

Our Risk-Controlled Investing strategy, recognizing that no single investment or strategy can assure success under all circumstances, seeks to help investors achieve a target rate of return over the long term that will meet their cash flow goals at an acceptable level of total risk. It also coordinates with your Planned Succession Management plans developed in the S-T-A-R-S System for Retirement SuccessSM. This is done through a written Statement of Objective and Investment Policy.

Risk reduction is essentially a matter of diversification, or spreading the risk.

Our Risk-Controlled Investing approach uses diversification strategies on three levels. We call this the Three-Dimensional Allocation. It is based on many years of studying markets and the work of many professional investors. It attempts to develop an investment approach that combines historical success with modern technology.

The first dimension in building a well-diversified portfolio is through investing in a very broad range of asset classes that will allow for some investments to do well when others are not. While past performance is not a guarantee of future results, it is possible to develop a Strategic Asset Allocation that, based on historical data, would have provided the optimized rate of return at a your acceptable level of risk consistent with your time horizon. This gives recognition to the fact that different asset classes perform differently under varying economic and market circumstances and when combined may provide a steadier long-term rate of return.

The second dimension of risk control is to diversify investments within each asset class. We then try to carefully select solid investments, both individual and managed. We use a database of thousands of funding choices and hundreds of money managers to seek the most appropriate investments for our clients. At the same time, we seek to reduce the risk of having too much money invested in one place.

The third dimension of diversification is through utilizing a broad range of investment strategies. This approach, we call Adaptive Value Investing, accepts the fact that no single strategy will succeed at all times. It acknowledges the fact that some strategies will not be doing as well as others under certain circumstance, but will be superior under a different set of conditions. This approach frequently utilizes the expertise of multiple outside investment managers from several different investment disciplines, which we employ in a cost-efficient manner.

Our portfolio structure has four strategy quadrants: Cash and Cash Generating, Core Equity, Inflation and Monetary Hedge and Adaptive Value Tactics. Each of these strategy quadrants holds a diversified group of asset classes and individual investments. As economic and market circumstances dictate, we adjust the balance among these quadrants in the attempt to achieve the desired risk-adjusted return. No strategy can guarantee results and past performance does not assure future success. However, this multi-strategy balance increases the probability of less volatile performance and more stable returns permitting a more reliable retirement cash flow.

Our primary concern is making sure our clients have enough retirement income to
last throughout their lifetime and, hopefully, meet their legacy planning goals.

So it is important that we focus on absolute returns at acceptable risk levels, which means having the cash you need when you need it. While there is never a guarantee, this focus is preferable to the usual focus on relative returns that consider it a success when only losing 20% when the “markets” a losing 40%. Absolute returns seek to meet cash flow needs regardless of external factors. In retirement, failure is not an acceptable option and large losses must be avoided if at all possible.

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