How We Manage Risk
To understand how we manage risk, it’s important to first define risk. To us, we think of risk as not having money when you need it.
Let us illustrate this concept with a very simple example:
Your car is 7 years old with 200,000 km on it. You know you’ll need $80,000 next year to replace it. You currently have $90,000 invested in your TFSA which you intend to use to facilitate this purchase. Imagine you have no other money, and cannot get financing to buy the car. Your TFSA is the only source of money available to you to make this purchase. Also imagine that your portfolio is invested 100% in the stock market.
Suddenly, there is some exogenous shock and the stock market drops 25-30%. Your TFSA goes from $90,000 to $63,000. Now, you can’t afford the car you planned to buy.
Yes, you can just buy a different car, or do repairs on your current car until your portfolio recovers. There are options. Now imagine if this were something where there were no other options, like meeting your standard of living in retirement or other?
How Do We Manage This Risk?
We approach risk management in two ways:
- Planning (discussed below).
- Portfolio Design (to be discussed in a later post).
Planning: Anticipating Future Needs
You may remember the MyGPS exercise you completed with us, or a more detailed financial plan you worked on with Chris Leslie or a member of our family office team. During these exercises, we asked you to give us an idea about your expenses (those to maintain your current standard of living and those to cover ‘wish-list;’ask you to list potential expenses you may need or want to cover in the next 3-5 years.
Using this information, we identify whether you’ll need to draw on your investment portfolio to fund those expenses. Even if the spending level or purchase isn’t 100% certain, we plan for it anyway, ensuring your portfolio is constructed to support your goals.
The “Low-to-No-Risk Bucket”
This portion of your portfolio is designed to safeguard capital for short-term needs. It’s made up of alternative investment solutions that are uncorrelated to traditional equity and fixed-income markets.
This means that even if equity markets drop (or rise) by 25%, these investments hold their value, ensuring funds are available when you need them.
Since markets typically take 2-3 years to recover after large pullbacks (think 20% or greater), we typically allocate enough to this bucket to cover 3 years of expenses. For those who prefer a more conservative approach, we can extend this to 5 years, though allocating beyond that is generally excessive.
Communication is Key
Our review process is comprehensive and consistent, but life can change between these meetings. If your plans or circumstances shift, don’t hesitate to reach out. Keeping your plan updated is critical to minimizing risk and ensuring your portfolio remains aligned with your needs.
Planning is the foundation. Without it, we can’t construct a portfolio tailored to your unique goals. We’re here to help you navigate life’s uncertainties and keep your financial goals on track.