Press Release: On January 25th, SC Public Radio host Mike Switzer interviewed Les Detterbeck. On that date, the Dow Jones Industrial Average (“DJIA”) was at 26,269; near its all-time high. Three weeks later, on February 20th when the interview was aired, the DJIA had dropped 5% to 24,884. Yet, the message was the same: Investors need to regularly review their risk profile and asset allocation.
Click here to listen to the audio http://southcarolinapublicradio.org/post/are-your-investments-getting-little-too-risky or please read the transcript below.
Mike Switzer: Hello and welcome to the SC Business Review. This is Mike Switzer. A regular review of your financial plan and investment portfolio is always a good idea. This is not just to make sure you are still on track to meet your goals, but to also make sure your risks haven’t increased past your initially desired risk threshold. And our next guest says that is an especially a good idea when financial markets have been setting record highs. Les Detterbeck is a Chartered Financial Analyst (“CFA Charterholder”) and a member of the South Carolina chapter of the CFA Society and he joins us from his office in Charleston, SC. Welcome, Les. Thanks for joining us today.
Les Detterbeck: Thank you, Mike. Great to be here.
MS: Les, first of all, please tell us how establishing a risk profile works for an investor.
LD: Certainly, Mike. There are three components of your risk profile. First, your risk capacity, or ability to withstand risk. Second, your risk tolerance, or willingness to accepts large swings in investment returns. This is how you are “hard-wired.” And, third, your risk perception, which is your short-term subjective judgment about the characteristics and severity of risk.
MS: I’m assuming people receive a questionnaire or an online form to determine all of this.
LD: That’s exactly right, Mike. There are different formats that are used for this and the result is to classify your risk profile into one of five categories of risk: Defensive (very low risk), Conservative (low), Balanced (moderate), Growth (high) and Aggressive (very high).
As a general rule, older investors would be thought to take on a lower level of risk than younger investors. However, that’s not always true. Investors in their 80s and 90s, who know that they have ample funds for their lifetimes and who can emotionally handle high risk, may have an aggressive risk profile; particularly when they plan to leave most of their money to their beneficiaries.
MS: And of course, a young person can be very defensive?
LD: By all means, Mike. And, people’s circumstances and risk profiles can change with life events, such as marriage, birth of a child, loss of a job, retirement, changes in health and others. So, it’s important to review your risk profile regularly.
MS: Les, walk us through the importance of reviewing the risk within your portfolio after some market cycles.
LD: What we suggest is you start by quantifying the risk you need to accomplish your goals. What market return is required to provide the likely outcome of success (also known as not running out of money)? Do the goals require a high rate of return just to have a chance of success, or is the demand on the portfolio low?
MS: The actual risk level of your risk profile can change over market cycles, right?
LD: Yes, it can. And, the emotional piece can be a big issue as cycles go up and down. Investors can become elated as markets climb and therefore increase their equity allocation for fear of missing out on the rally. And, then as the markets decline, they ultimately reduce their equity allocation just as stocks hit bottom. Instead, we suggest that you establish an appropriate risk profile and asset allocation to meet your goals and stay with it through the long-term.
MS: Once you’ve stuck with your asset allocation, then you need to rebalance it, correct?
LD: Yes, rebalancing is huge.
MS: How often should you rebalance?
LD: At least once a year, Mike, though 2-4 times per year is much better with all the changes in our world. You do this by comparing the asset allocation in your portfolio to your target asset allocation. You split your holdings into the three asset classes; equities, fixed income (including cash) and alternatives and calculate percentages for each. A balanced portfolio might have a target of roughly 50% equities, 25% fixed income and 25% alternatives. In a bull market, your equities will outperform the other asset classes and when you compare your actual asset allocation to your target, the equity percentage will very likely exceed your target. This means your assets are more risky than your plan and you need to rebalance by trimming back your equities and getting your allocation back into your desired risk profile and asset allocation.
MS: Les, thank you so much for your insight and your time today.
LD: Nice talking with you, Mike.