Let’s talk about that risk profile – yet again
This is the fourth article in a series designed to help you get the very best out of your financial adviser. If you’re already a client of Sovereign Wealth Partners, hopefully you’ll recognise the process and feel empowered when we revisit these conversations. Your aim is to be confident that you can live an extraordinary life backed by wealth that’s beautifully aligned with everything that’s important to you.
Remember though, extraordinary advice partnerships are elusive. So the conversations are probably not what you’d think.
There’s a hypothetical exercise called risk profiling that you’ll do in one of your initial adviser meetings. It’s like a personality test on investment risk, so the eventual portfolio you’re recommended matches the risk you’re prepared to take.
You might have forgotten all about it. It might have seemed a little contrived or simplistic. But you should know that this risk profiling, more than anything else, is likely to be the primary driver of the long term returns in the portfolios we recommend. It'll impact the highs, the lows and the long term compounding. This is because the portfolio mix we recommend is designed to match your risk profile. So, take the time to discuss it again with your adviser. Take the risk profiling test again if you like. The test might seem clumsy but there are so many nuances to getting this right. A good adviser will know that when investment markets are going well, investors have a higher appetite for risk than when things are going badly (they seek more upside and believe they can cope with more downside). And move beyond the hypothetical – how much did your portfolio fall during the COVID carnage of March 2020? Broad sharemarkets around the world fell around 35%. Did you lose any sleep over your portfolio? What about the Global Financial Crisis? Sharemarkets halved. Most portfolios took 4-7 years to recoup the lost ground even if they were well diversified. Did you feel compelled to cash out irrespective of your adviser’s advice? Or were you caught short of cash – did you have to sell assets in distressed markets?
The tricky thing with risk profiling is that no one knows when or how severe the next downturn will be. But we do know is that a downturn will come some day, that’s the nature of the game. So, in our business we talk about a one in twenty year downturn. The sort of downturn that comes once a generation. What is the greatest loss you could live with psychologically? And what is your financial capacity to absorb investment losses? If we know where your limit is for a one in 20 year scenario, then with the help of experts we seek to construct a portfolio that delivers the maximum compounding return in the good times, but at the same time is unlikely to push you beyond your limits in the bad times.
And whilst we’re on the subject, another good conversation is to talk about all the different things we can do to limit the downside risk. There’s no single magic bullet but there are plenty of techniques worth chatting through.
Another approach is to notionally allocate your investment wealth into buckets. How much will you use in the next year? How much over, say, the next ten years? How much of your wealth has no real time horizon – it may well stay invested beyond your lifetime? Each of these buckets can be given its own risk profile, suiting you and your timeframe. The longer the timeframe, the longer you can wait for markets to improve after a downturn. A bucketing approach keeps you focused on both the short term and the long term.
So, have these conversations with your adviser regularly. When the next downturn comes, as it surely will, you won’t be compelled to do something you’ll regret – like sell out at the bottom of the cycle. Rather, you’ll see the fall as an inevitable part of the cycle. Often its a great opportunity to buy good investments cheaply.
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