Measure Risk Will Affect the Success

When financial advisors (stock brokers at the time) would ask (that’s assuming they did ask and not simply check a box) it was a multiple choice with options such as conservative to moderate to aggressive with maybe a couple of options in between. Back at the turn of the century, the industry added a little more emphasis especially as the population aged on articulating the five or eight multiple choice answers to gauge and to make recommendations based on the client’s comfort level of risk.

Nothing epitomizes this financial planning term than the advent of Target Funds. One core belief is all that is ever saved for something big is that the older you get the less risk you should take. Seems reasonable, but some very bad things happen within the uncertain cloud of reasonableness. However, there is some wisdom in not treading in bumpy waters when you have less time to recover from market corrections. So, what could go wrong with that logic?

Target Funds have their place in retirement plans and 529 plans. An easy access to a hands-off professionally managed account whose embedded promise is to lower the volatility of the portfolio by rebalancing into a higher concentration of fixed income assets while the equities move towards blue chip and dividend oriented stocks. Increasingly safer asset management may prove to be more detrimental to the objective rotating away from loss and straight into a disparaging risk v. reward ratio. Considering the high cost of management embedded in these types of assets, there is no wonder why those institutions love them so much.

Think about this way. As your portfolio gets closer to target date, the less active management is involved in your portfolio. Simply stated there are less costs involved in number and quality of staff, ongoing research and trading fees for the fund which translates to higher profitability for company all the while you are exchanging advisor fees for lower volatility. Bottom line, your net rate of return you receive on the risks you are taking with your portfolio is not in your best interest. But to be fair, we must measure how much do the advisor fees impact the rate of return and we also must measure quantitative amount of risk inherent in every investment.

As a true steward of your money, there is one foundational principle that cannot be disputed, yet it is never discussed. It’s not mandated by the government agencies, compliance officers or financial planning, yet this principle almost always is an integral part of investing. Many companies and financial planning software programs start the process of measuring risk in a portfolio as it compares to the stated tolerance level. With linear statistics, these retirement tools create an ambiguous rating or number system that is supposed to tell you if your portfolio is within or outside of your risk tolerance. This is primitive at best and dangerous at its worst. How the industry measures risk and the process they go about it is backwards and if not understood and corrected, there are going to be a lot of depleting portfolios the next time we have even the slightest market correction.