Investment portfolio risk can be an uncomfortable topic.
It’s easy to find articles all over the internet that encourage people to sit tight when things are dropping. Warren Buffet’s famous instructions regarding his wife’s trust are to put 90% of it in the S&P500. And since Warren Buffet says to do it, a lot of people think we should all do the same. (side note, with all that money invested, or course Warren Buffet wants others to sit tight! He’s a rational investor, not a charitable organization!)
But is it working? According to Dalbar, the research firm, while the stock market in general has returned just under 10% a year historically, the average investor only earns over 5%! Why is that? The reason comes down to investment portfolio risk. They don’t enjoy the ride as much as the hoped-for destination. So when the portfolio keeps dropping, they begin to doubt they will ever arrive.
So they call you, the advisor. If you are like most financial advisors, you will coach them on hanging in there, after all, the portfolio is designed to help them meet their future goals. But what if they are just uncomfortable with that amount of risk? Then you might lose them with your message, or lose them as a client.
Perhaps a question to ask yourself is, are your model portfolios too risky?
So How Can Your Reduce Investment Portfolio Risk?
Whether you have model portfolios for each individual, or a set of 5 or 10 that you apply based on risk profiles, you can find ways to reduce portfolio risk.
First, when you built the portfolios, you may not have optimized them properly, leading to a lessening of the benefits of diversification. This leads to greater risk than necessary, which leads to uncomfortable clients.
Next, your allocations might not effectively minimize the risk of the investments you’ve chosen. This is not the same as the first point: This isn’t about asset allocations, rather allocations to individual investments to meet those allocations.
And last, there may be other investments that will, by adding them to the portfolio, reduce risk while again not making a big impact on expected returns.