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Risk Management
Investment risk is real. During a bull market, when most investments are appreciating in value, risk is often overlooked. But when risk finally shows up during a market downturn, investors become dismayed. Many investors then discover how concentrated their investment portfolios were. On the other hand, other investors fail to take enough risk to achieve the asset growth needed to satisfy their financial goals. Because the risk of inflation is greatest for retired fixed-income investors, we often counsel them to diversify with modest allocations to equities.
Modern Portfolio Theory holds that risk and return are directly related, and that the reward for taking higher risk is the potential for higher returns over time. In portfolio design, risk is controlled by asset class allocation.
We take into account three main issues when assessing the level of risk appropriate for a client:
1. The ability to take risk. The longer the time horizon for the investment, the more risk can afford to be taken. This is because history has shown that equity markets do not produce losses over extended time periods.
2. The willingness to take risk. Some investors are very uncomfortable with financial risk. Short term loss in value of a portfolio may be something that an investor just cannot "stomach." Retirees have the added risk of simply outliving their savings as a result of longer life expectancy coupled with the potential for expensive assisted care.
3. The need to take risk. Older, wealthier investors who already have a portfolio sufficient to meet their financial goals do not need to take greater risks with their assets. The preservation of capital becomes the primary objective.
We prepare an Investment Policy Statement for each client that addresses these three issues and the consequent risk that the client assumes for his/her investment portfolio. The asset class allocation is specified in the IPS which serves as a plan for managing the portfolio into the future. Life changes will result in changes to the IPS over time, so it is truly a living document that we will review periodically with our clients.
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