In this article, we:

  • Delineate three common portfolio risks.
  • Explore how the risks of losing, outlasting, or diluting the purchasing power of your money could threaten portfolio values, asset sustainability, and the ability to fund goals and meet expenses.
  • Describe analytical software with sophisticated capabilities that is designed to manage and mitigate these risks.

In managing an investment portfolio aimed at both preserving and growing wealth, it’s critical to periodically revisit the various forces that could present a threat to those goals. But before portfolio risks can be managed, they need to be identified. With that in mind, let’s look at:

  1. The risk of losing your money. First, let’s define terms. Volatility—up and down market movements—is a measure of the variability of an investment’s returns. The industry standard for measuring volatility (“standard deviation”) aims to assess the risk of a security, asset class, or portfolio, i.e., how much returns “bounce around” over a market cycle.

We prefer a complementary risk measure that focuses on drawdown exposure, which reveals the most you could likely lose in portfolio asset values, measured from where you are at any one point in time to the eventual bottom, or trough, of that cycle. This is a more tangible way of illustrating what could happen in a very bad market environment, because it is more consistent with what a person could actually experience. In our experience, investors are typically less concerned with how much their portfolio returns are likely to fluctuate in a given year and far more concerned about the maximum capital loss they could they could withstand at any given time.

  1. The risk of outlasting your money. Longevity risk exists when investors live longer than expected, or they start to withdraw money from principal at a rate that increases over time, and the rate of return their portfolio earns does not keep up with the increased rate. According to the Centers for Disease Control, in 2016, the overall life expectancy was 78.7 years.

Of course, when you talk about life expectancy in regard to portfolios, you’re really talking about the need to structure your assets in such a way that creates sufficient cash income to fund expenses. Investors should think about living expenses as well as goals that require significant funding, such as college, retirement, or major purchases. And the planning often needs to extend beyond one’s lifetime to include setting a target amount for passing on wealth to family or charitable endeavors. By incorporating such goals in the analysis, you can determine the probability of meeting those goals and select the investment strategy that provides the highest probability of meeting those goals.

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