Managing Risk

Asset allocation refers to the strategic distribution of an investor’s funds among various asset classes, such as stocks, bonds, and cash equivalents, within their investment portfolio. This process aims to achieve a balance that aligns with the investor’s financial goals, risk tolerance, and time horizon. Many portfolios are considered to have appropriate asset allocation (for the investor’s risk tolerance and investment horizon) when a certain percentage of stocks and bonds is achieved (ie 60% stocks, 40% bonds).   

The Rule of 100 is a guideline used in investment strategy to determine the appropriate percentage of stocks an individual should have in their portfolio. The calculation involves subtracting the investor’s age from 100. For instance, if someone is 60 years old, the Rule of 100 suggests allocating 40% of their portfolio to stocks.  This rule is quite general and certainly not applicable to everyone. 

Recognizing the increasing life expectancy of individuals, the Rule of 110 has emerged as an adaptation of the Rule of 100. Following a similar principle, the Rule of 110 involves subtracting one’s age from 110 instead of 100. This modification acknowledges the extended time horizon for potential investment growth and suggests a slightly higher allocation to stocks.

While this approach has been found to be successful in the past, lets consider another way to think about risk management.

First, some questions to ponder:

What percentage of your portfolio, or what specific dollar amount would you need in any realistic worst case scenario?

If you lost your job how long do you think it would take to find another one, and how much money do you think you would need in the short term?

What about a major issue with your home, like a sizable repair?

Do you have access to a home equity line of credit? If the answer is yes, then perhaps your safety blanket does not need to be as significant since these specific lines of credit typically have a relatively low interest rate.

When you come to a safe figure for yourself and your family, this could be the number allocated to the safe portion of your portfolio. Now the safe portion could be invested in bonds, however as investors saw during periods of 2021 and 2022, bond markets can fall considerably at the same time as stocks. This period of decline for bonds was due to inflation, and gives investors reason to consider alternative investing methods to minimize risk and ensure their worst case scenario safety blanket will be intact no matter what market conditions could be present.  Some options include GICs, high interest savings accounts and ETFs and money market ETFs. 

In addition to a robust financial safety net and strategic asset allocation, insurance coverage plays a pivotal role in shielding your investments from unforeseen challenges. Life and disability insurance are essential components that provide a layer of protection for both you and your loved ones.  For those in the US, health insurance is indispensable for covering medical expenses and mitigating the financial impact of unexpected healthcare costs. Adequate health coverage ensures that you have access to necessary medical treatments without depleting your savings.  Other types of insurance can be considered as well: property and casualty insurance, long-term care insurance, umbrella insurance and critical illness insurance.

This is beginning to look much more complicated than the 100 rule. While basic investment principles like that are applicable to some individuals, those with more intricate financial situations may benefit from the expertise of fee-based financial advisors. These professionals offer personalized guidance, taking into account the complexities of your financial landscape. Fee-based financial advisors offer a transparent and objective fee structure, charging for specific services rather than a percentage of assets under management (AUM), reducing potential conflicts of interest. This approach often provides clients with tailored financial planning services and unbiased advice, aligning the advisor’s interests with the client’s financial goals.

In reconsidering traditional approaches to risk management, this exploration underscores the importance of a nuanced and personalized strategy. While asset allocation, guided by rules like the Rule of 100 or Rule of 110, can provide a foundation, it’s crucial to expand the conversation beyond simple percentages for those with more complex financial situations. By posing critical questions like the ones we have discussed, investors can tailor their risk management plan to their unique circumstances. In navigating this intricate terrain, the key takeaway is the necessity for a holistic, adaptable, and personalized approach to risk management that goes beyond conventional rules to safeguard financial well-being effectively.