Balancing Risk & Reward: Are you over exposed?
By J. Tyler Thompson, CFP®, CEPA®, AAMS®, WMS®
Investors often want an outsized annual return on their portfolio — 10%, 12% or more.
Yet most tend to be strongly opposed to risk, and may not understand the risk associated with having an asset allocation looking to deliver those frothy returns.
Hitting a 10% return sounds great, but too many people fail to understand the amount of risk they are taking with those investments until it’s too late and there’s a market correction.
Even worse, a recession occurs and their riskier asset allocation makes them feel the full impact of the market's drops, which in previous downturns has exceeded 25-30%.
A better approach is to take a more measured and purposeful mindset to balancing risk and reward.
We spend a great deal of time learning about each client’s needs and wants, and educating them about how different investment instruments and assetclasses work.
We take time to understand their risk tolerance and fears, and create a comprehensive financial plan that identifies what annual return they need to reach to achieve their goals and objectives, and how we can accomplish that while taking the least amount of risk.
Monte Carlo Simulations
We use sophisticated financial modeling tools such as Monte Carlo simulations that run thousands of calculations to predict the probability of different outcomes alongside the intervention of random variables.
Monte Carlo simulations help explain the impact of risk and uncertainty in forecasting and prediction models so we can use that data to guide clients through more informed decision making.
For example, we may walk clients through a risk tolerance test that takes their current allocations and runs them through a simulation of the Great Recession of 2008. Seeing their risk exposure in that context usually has an eye opening impact.
After walking them through our process, many clients realize that they’ve been taking too much risk.
They thought a 10% return was necessary, when in reality a 4% return may meet their goals and reduce their market risk dramatically.
Rethinking your appetite for risk is a savvy way to protect your wealth and still achieve long-term objectives.
Any opinions are those of J Tyler Thompson and Capitas Advisory Group and not necessarily those of RJA or RaymondJames. The information contained in this report does not purport to be a complete description of the securities, markets, ordevelopments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation.