The Constant Tension: Risk vs. Return
When I was studying to obtain the CERTIFIED FINANCIAL PLANNER™ certification, one of the first definitions I had to memorize was the meaning of risk--the possibility of loss. Risk is everywhere in our world, and as your advisors it is our job to help you identify these risks and find the most effective means to reduce or eliminate them.
When it comes to investments, we take the tradeoff between risk and return very seriously. In fact one of our core missions is to find and deliver the best risk-adjusted return. That’s just a fancy term that says we try to take the least amount of risk to get you the most return. It’s extremely important not to separate the risk and the return, especially in the 9th year of a bull market and after a year like 2017 when many of your friends may be bragging about their stellar returns. For instance, your friend’s portfolio may have made more than the S&P 500 last year, but what kind of risk did they have to take to achieve that return and how will it perform in a down market? Don’t forget—while higher risk brings a higher potential for return, it also brings a higher potential for loss.
For example, in 2017, one of the top performers in the mutual fund and ETF universe gave a staggering 105.7% return! (The fund name has been omitted to protect the innocent!) That sounds nice, but you wouldn’t enjoy that fund in 2011 when it returned -43.3%. The fund has 4 times the volatility than the S&P 500 as measured by standard deviation. (Standard deviation measures the level of variation in returns and is used to gauge risk in the financial services industry.) So while it had amazing returns last year, you would need to be able to stomach a wild roller coaster ride of extreme highs and lows if you owned this fund.
The chart below illustrates the theoretical relationship between risk and return; however, reality is never a straight line. Very volatile investments often lose their investors too soon to see long-term rewards materialize.
From our own experience, not everyone deals with risk the same way. We use a discovery process to identify your unique risk tolerance to find your “Risk Number”. We then craft a portfolio that matches your personal preferences, giving you a broadly diversified portfolio that will provide consistent returns.
We continually scan 27,000+ mutual funds and ETF’s to identify the very best risk-adjusted performers in a variety of categories. Each investment has its own risk/reward characteristic. Once assembled, your portfolio will have a risk number that aligns with your comfort level and expected outcomes.
Don’t remember your Risk Number or want to find out what it is? Contact your financial advisor and we’ll send you the 2-minute questionnaire. We can even capture the risk number of a portfolio held at other firms so you can make sure you’re appropriately positioned no matter what the market does in the future.