As with the famous tortoise in his race with the hare, flashy performance is not always the winning recipe. The same is true for investments. Sometimes not losing can be better than a big win. How do you determine your personal risk tolerance? How can you protect your capital? Let’s think about that together with a couple of tests.
The first is the statement test. Do you look at your statements and compare them to previous reports? Have you ever opened a statement and called your advisor with a queasy feeling in your stomach? Have you ever thought that you can’t stand it anymore; you are moving everything to cash? Have you ever been unable to sleep because of the performance of your investments? If you answer yes to any of these questions either your tolerance for market volatility is very low; or, your understanding and context for the purpose of your investments may need some clarification. Either way, you should discuss your feelings with your advisor and make the adjustments needed to calm your concerns.
The second is the math test. When thinking about your tolerance for risk, convert percentages into dollars. For example, you may see a statement saying “I am a moderate investor and am willing to tolerate periodic declines in my account of up to 10% from time to time.” Rephrase the question to say, “I am a moderate investor and am willing to tolerate periodic declines in my $500,000 account of up to $50,000 from time to time.” You may be able to agree with the first statement but you may choke on the second. Dollars are more real to you than percentages.
Understanding your own personal investment comfort zone is an important step in designing an appropriate portfolio. Having determined what your needs will be, you can then design an investment strategy within that comfort zone. Staying within those boundaries will increase the likelihood that you not abandon the program based on short term movements in the market. We know that markets move dramatically from time to time.
There are techniques available in the market place that will allow you to put a safety net under your investments that could increase your “Sleep Well” factor. Some programs are offered by insurance companies and others by investment companies. There are some techniques which have been used for decades in investing to limit downside risk. Let’s look at a few.
Deferred annuities can be purchased with a variety of protection riders. You can guarantee withdrawals, income or death benefit. These guarantees are backed by an insurance company so it is important to use companies with good financial underpinnings. This is one means of protection available for a cost.
If you have a brokerage account and hold individual securities, you can put a “sell stop” order in place to prevent the value from going below a predetermined price. If the value drops, the sell stop order will become a market order and sell your position, preventing further loss.
Some programs offer a Principal Protection Overlay. This approach monitors a portfolio for significant market declines. At predetermined trigger points, portions of the account move into a safe investment to protect your principal. When the markets recover, funds are reinvested into the portfolio. The theory is that by limiting the downward loss, you can restart from a higher balance resulting in a greater account value.
No approach is perfect and they all have costs involved. However, after experiencing the stress of market downturns in 2000-2002 or 2008, cost often is a matter of perspective. Cost is what you pay. Value is what you get for what you pay. There are times you can win by not losing. Protecting your capital lets you sleep well so that someday you can eat well.
We welcome your interest in these ideas, let’s talk.
By David M. Wheat, CFS, ChFC
Senior Advisor, Axiom Advisors, LLC