Atlantic Capital Management

Atlantic Capital Management (100)

Tuesday, 30 July 2013 00:00

Risk Tolerance for DIY Investors

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“Only a very brave mouse makes a nest in a cat’s ear.” -- Danish proverb

The concept of risk tolerance, while fairly simple for most folks to grasp, is nonetheless a core foundational concept in DIY (do-it-yourself) investing that really shouldn’t be taken lightly. Many DIY investors give risk tolerance a cursory nod while putting together their portfolio strategies, or spend a little time online taking one of the generic risk tolerance surveys that can be found at various financial research and opinion sites. Younger investors often make the mistake of discounting risk tolerance altogether, rationalizing that large fluctuations in an aggressively risky portfolio can be “smoothed out” over time…after all, they’ve got a lot of years of working and investing ahead of them, right? Older, more established investors sometimes overlook the importance of risk tolerance because their asset mix is better developed; they may not worry too much about the risks inherent in their equity-heavy portfolios because they have other, more stable assets (real estate, for example) on hand. Fundamentally, both of these rationalizations are only partly problematic. Younger investors usually DO have more time to experiment with higher-growth, higher-risk investments. Older investors usually DO have a stronger mix of assets and/or higher income potential, mitigating the possibility of being completely wiped out by an equity-heavy portfolio that performs poorly in bad market conditions. The real issue at hand for DIY investors isn’t really tied to economic circumstances or station in life so much as it is tied to the willingness to withstand the emotional and mental peaks and valleys that come with investing hard-earned money in an industry that’s fundamentally, well…risky.

 

Our investment philosophy is first and foremost governed by processes and practices which put an emphasis on effectively managing risk. Beyond advising clients directly about the varying levels of risk tolerance that might be suitable for their purposes, all of our back-end processes are built with risk-managed investment firmly in mind. (You can get a good overview of our investment methodology by clicking here.) We strongly believe that no family, whether they are investing with Atlantic Capital Management, Inc. or striking out on their own, should throw caution (and money!) to the wind when it comes to evaluating the tolerance for risk. Below, we’ve outlined two important things to consider when formulating a risk tolerance strategy for a DIY portfolio.

 

What am I willing to lose?

 

Like it or not, this is the fundamental question at the heart of establishing a risk tolerance strategy. Given your current and predicted future income scenario, your lifestyle needs and expectations, and your personal willingness to hold off on pushing the “panic button” when things start to go south with your portfolio (as they inevitably will), what kinds of losses are you willing to bear while you weather the ups and downs? To put some real-life “oomph” behind this question, consider the following research from Wells Fargo: during the precipitous market decline from 2007 through 2009, equity portfolios and equity-focused retirement plans like 401(k)s lost a little more than 50% of their value. While many of those losses have been made up over the ensuing years, it was a long road back for many individual AND institutional investors. All things considered, could you withstand the loss of 50% of your equity positions? 20%? 10%? As food for thought, let’s revisit our “younger vs. older investors” scenario from above.

 

If you’re in your late 20s or early 30s, making headway in your career, and enjoying the benefits of having a two-income household, you might realistically be able to say that losing 50% of the value of a “high-growth” portfolio is something that you could withstand. (Although we bet you’d say it through clenched teeth!) After all, you’ve got a long road ahead of you, and “a rising tide lifts all boats,” as the financial pundits are wont to say. But what about your non-retirement investment strategy? What if the portion of your portfolio you were setting aside for your child’s education expenses dropped by 50% the year before you needed to access it? That would very likely make a significant impact on your plans to fund at least the first couple of years of college or private school. Under those circumstances, your tolerance for risk, which would normally be fairly high given your station in life, suddenly becomes a significant factor in potentially limiting an important life goal.

 

In the wake of the economic meltdown outlined in the research above, we heard many stories of people close to retirement age who watched with shock and dismay as the value of their retirement accounts plummeted. As mentioned above, it’s not uncommon for older, more seasoned investors to have a broader mix of assets that can serve as a shelter from the storm in times of crisis. Consider, however, the double-whammy of declining portfolios and free-falling property values, which affected nearly everyone in the wake of the 2007-2008 fiscal crisis. In Massachusetts, for example, average property values have fallen 15.7% since 2007, with many communities north, west and south of the city seeing declines as high as 39%. Suddenly, investors who were counting on weathering the storm by leveraging their low or no-mortgage real estate assets have a much smaller safe harbor than they originally thought they would!

 

Regardless of where you are in life or in your investment planning process, we can’t overstate the importance of asking yourself, with all of the realism (and maybe even some pessimism) you can muster, what you’re willing to lose as you chart your risk tolerance course.

 

How do I develop a risk tolerance scenario?

Developing a risk tolerance benchmark for a DIY portfolio can be tricky. Fortunately, there are some fairly good free resources available which can help you do just that. (Alternately, if you’d like personal assistance with creating a risk tolerance profile, we’ll be happy to provide a free consultation at your convenience.) The following tools and services are good places to start putting together your DIY risk strategy.

 

Risk tolerance surveys

Nearly all of the major financial services companies and opinion websites feature risk tolerance surveys. Some of them are fairly bare-bones, while others are interactive and sophisticated. Most consist of a small number of scale-based questions, and produce results that both categorize your risk tolerance and produce suggested asset allocation charts. We generally recommend the more “neutral” surveys offered by organizations like Morningstar and FINRA (the Financial Industry Regulatory Agency), rather than those connected to the big investment firms.

 

Researching worst-case scenarios

Analyzing the historical worst-case returns for certain types of assets and securities can give you an eye-opening look at exactly how much upheaval you’ll be comfortable with in the event that your investments take a hard or sustained hit. This data is available from numerous sources, including FINRA, the Securities and Exchange Commission, and the Congressional Budget Office.

 

Understanding asset allocation

We strongly encourage DIY investors to develop a healthy understanding of the concept of asset allocation, particularly as it relates to multi-asset allocation. (Atlantic Capital Management utilizes a proprietary fundamental and technical strategy to define multi-asset-allocation strategies for our clients.) Most of the recommendations you will get from risk tolerance surveys and other types of research focus very heavily on asset allocation because this is a time tested risk management tool. It imposes discipline to the investor and by the virtue of rebalancing, it provides a buy low sell high benefit. Again, we think you’re better off utilizing the more general research found in this area, rather than that espoused by the big financial players, who often have the performance of their product lines, rather than your individual needs, at heart.

 

All investments carry risks; developing a risk tolerance strategy for a DIY portfolio doesn’t have to. We wish you success in defining this important aspect of your investment scenario, and encourage you to contact us at Atlantic Capital Management if we can be of assistance.

 

Wednesday, 24 July 2013 00:00

The 4 “Rs” of Low-Risk Investing

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Last month I talked about assessing your need for life insurance to protect your family. This month I want to examine the basic elements of investing. Despite how the “big guys” of financial services industry might like to otherwise portray it, all forms of investment involve an element of risk. Even with the current availability of huge volumes of free research and opinion, managing risk in an investment portfolio is something that many people who take a “DIY” (do-it-yourself) approach struggle with. Understanding the core strategies for developing a low-risk investment portfolio is critical, and can mean the difference between ensuring your family’s financial future or losing most (or all!) of the money you’ve worked so hard for. We call these strategies the 4 “Rs” of Low-Risk Investing, and we present them for you briefly below.

Risk Tolerance: Perhaps no concept is more important to a low-risk portfolio than that of risk tolerance. Clearly defining and understanding your personal tolerance for the risk involved in the investment products you choose is absolutely crucial to a DIY scenario. Are you comfortable with high-risk products like sector-based equities and index funds, or do you want safer but slower-growth products like Treasury Bills and bonds? Determining the right mix of products that meet your personal risk-management strategy is the very first place you should start.

Research: Once you’ve determined your risk tolerance, it’s time to do the research you’ll need to both quantify and adjust your risk-management strategy. You’ll find no shortage of free research on the Internet, but beware: not all research is good research, and some of it is downright horrible! Cross-check opinions and advice from various sources. Don’t rely solely on ratings, performance snapshots, or benchmarks. In our opinion, focusing heavily on “outperformance” gets a lot of people in trouble! Do your due diligence with your risk-tolerance profile firmly in mind.

Realism: It’s important to be realistic about your investment goals, and to build and manage a portfolio that matches them as closely as possible. For example, if you’re in your 20s or 30s, you might have higher risk tolerance for your retirement portfolio than for the investment strategies you need to put your kids through college. Ask yourself “Realistically, given my current and anticipated future circumstances, what can I expect from my portfolio over the next 5, 10, 20 or more years?” Make decisions about the mix and relative risk of investment products from there.

Right-Sizing: Be judicious about how to fund your portfolio. We’ve all heard the stories about people pouring their money into shaky investments, or day-trading it away. Unfortunately, those stories happen all the time. Take the time to think hard about your present and future liquidity, and how that liquidity can be applied to your investment strategy. Benchmark constantly against your risk tolerance, and make adjustments as circumstances warrant.

William C. Newell, Certified Financial Planner (CFP), is president of Atlantic Capital Management, Inc. a registered investment advisor located in Holliston, Mass. With Wall Street access and main street values Atlantic Capital Management has been providing strategic financial planning and investment management for over 25 years.

 

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