This is article one in a five part series on the topic of RISK. The articles will be as follows:

  1. Determining the Appropriate Risk Level for a Portfolio
  2. Why have bonds (a ‘safer’ asset) gone down in price recently?
  3. Why equities are ‘riskier’, but offer higher potential long-term returns
  4. Understanding volatility (risk vs. reward)
  5. Countering Investor Behavioural Biases (How to protect yourself and your portfolio from making emotional mistakes)


Part one – Determining the Appropriate Risk Level for a Portfolio

10922382_s2One of the greatest disconnects between investment professionals and their clients is understanding and interpreting risk.  For most investors, risk is essentially the potential that an investment could lose money (typically over a short time period).  In particular, an investment is considered more risky if there is a greater probability of a loss (negative return) and if that loss could be substantial.   But, focusing solely on this singular view could lead an investor to miss out on opportunities for higher return and the danger of not having sufficient funds for retirement.

For example, an investor owning a portfolio of only GICs believes she is taking on zero risk as the GICs, if held to maturity, should give her back her principal investment plus a small amount of interest.  But, if the investor needs to earn a return of 5% per annum to fund her retirement, a portfolio of GICs paying 2% actually has a great deal of risk – the hazard of not meeting her investment goal.  In this scenario, the investor is at a 100% risk of not meeting her retirement goals, requiring her to work longer or reduce expenses substantially during retirement.

Determining Risk Level in Your Investment Portfolio

Instead of focusing solely on short-term losses or gains, you should consider the following three questions to determine your appropriate investment portfolio for retirement planning:

  1. What is the minimum return / level of income needed in retirement?
  2. What is the desired return / level of income wanted during retirement?
  3. How much loss (as a percentage or total dollar amount) can I withstand (typically over a short time frame)?

The first question addresses the minimum amount of return that needs to be earned to ensure that you can enjoy a basic lifestyle in retirement.  This is the amount that must be safeguarded against.  But the key issue here is time horizon.  If you are in or near retirement, AND you cannot risk losing a significant amount in a short time period, the portfolio would generally be income oriented and conservative.  By contrast, if you are in your early 40s, you can invest more in assets that have a higher return potential, but still have more chance of a potential loss in the short-term, such as equities (stocks).  The younger investor can accept a decline because she has a longer period to recoup those losses when market returns are stronger.  This occurs over nearly all medium-term and longer term periods (5 yrs +), where riskier assets like equities have provided higher total returns.

The second question addresses the kind of lifestyle you would like to have in retirement and then placing a dollar value on it in terms of after-tax income to ensure there is enough money for travel, entertaining and gifts.  A higher return is often necessary to attain the desired lifestyle.  Risk is managed by rebalancing, so taking profits (selling) when equities have gone up and over time increasing the allocation to more income oriented and conservative investments.   Often the cash (or GIC) position is increased for near retirees to ensure the minimum level of income is attained, but then taking a bit more aggressive approach with the remaining investments to attain the desired lifestyle.

The third question requires complete honesty, because investors are most tempted to stray from their investment plan when markets decline.  These are often the times when it is most important to stay on the plan, particularly as equities (stocks) tend to go up after markets have gone down.  If you cannot accept any loss greater than 5% without wanting to sell everything and becoming extremely nervous and agitated, then you should have a zero percent allocation to equities and a low allocation to longer maturity and/or higher yielding bonds .  It is better, if you are highly risk averse to forego potential  gains in order to save yourself from the pain of losses.  If you are working with a financial planner / investment advisor, he /she should set your equity or riskier asset weighting based on a typical bear market (20-25% decline) to an extreme bear market (50% decline).  E.g. if an investor is willing to accept a potential 15-20% decline in their investments than an equity (stock) allocation of approximately 50% would be appropriate (a 35% decline, which is the midpoint between the two decline scenarios of 20% and 50% multiplied by .5).

A TriDelta Financial planner can work with you to determine the proper investment allocation to meet your goals and to set a plan in place to meet those goals by working with you to answer the three questions listed above, but being forthright and honest about current net worth, income, attitude towards loss, retirement expectations and any unique circumstances (health concerns, an inheritance, selling or buying of a property, etc.) will make this process and your financial plan more successful.

Lorne can be reached at and by phone at 416-733-3292 x225.