September 4, 2021
Here are some of the strategies used by professional to mitigate risks at all levels of an accumulation portfolio.
Most investors know that risk is a normal part of investing when seeking higher returns. In my last article called “Managing Investment Risks in Your Portfolio”, I identified the various risks associated with traditional investments and identified some strategies used to manage them. In this follow-up article, I will elaborate on these strategies and explain how they help mitigate investment risks.
How to Manage Savings Risks
First, let’s look at how we manage the risks of not meeting your savings goals. These “savings risks” can be properly managed with financial planning strategies such as financial projections and account allocation. Having a strong personalized financial plan which includes accumulation and decumulation projections will help quantify your goals. When done properly, these projections consider most savings risks like inflation risk, reinvestment risk and show you if you need to modify your strategy to reach your goals. Account allocation is another financial planning tool used to mitigate savings risk. When a financial plan takes into consideration your financial situation to allocate funding and investment assets into the appropriate account types, this can help maximize your savings efforts by optimizing the tax benefits of registered accounts and using the proper accounts for each goal. Using TFSAs, RRSPs, non-registered accounts and corporately owned accounts strategically for maximum effectiveness will go a long way towards helping you meet your goals.
How to Manage Investment Risks
Next, let’s look at the risk that an investment doesn’t perform as expected and inflicts undesired outcomes for you and your plans. This “Investment risk” can be managed by taking the time to develop personalized investment policies for your portfolio to guide your investment plan and its ongoing management. A good investment policy will provide a formal understanding of your ability to take on investment risk as well as your willingness to take on investment risk. It will take your financial situation, investment horizon, liquidity needs as well as your attitude towards risk into consideration and help define your ideal relationship with investment risk. This evaluation of risk tolerance can be matched to a suitable portfolio and its expected returns which can then be used in your financial projections to set expectations.
How to Manage Security Selection Risks
Lastly, let’s look at the risk of choosing the wrong securities (like stocks and bonds) to invest your savings. “Security selection risk” can be managed with portfolio management strategies like diversification and security analysis which can minimize the risk of choosing the wrong investment security, which could do irreversible damage to your portfolio. Diversification is the strategy of allocating your investment capital across various securities so that a negative outcome in one security can be offset by the performance of other securities in your portfolio. Diversification’s effectiveness can be enhanced when analyzing your securities’ expected correlation with one another’s performance. Assets that have highly correlated return expectations won’t balance out your portfolio expectations as well as assets that have low or even negative correlation expectations. Effective diversification is highly regarded as the essential risk management strategy to mitigate security selection. Besides diversification, an investor could also choose to manage a concentrated portfolio of securities and use security analysis as his risk management strategy. Fundamental security analysis and technical security analysis have their place in portfolio management strategy. However, they have not been proven as reliable as diversification to manage risk for the average investor.
As you can see, there are as many types of investment risks as there are ways to manage them. In the end, the best investment plan is one that includes strategies to deal with all the risks above in a comprehensive financial plan.
Marcel LeBlanc, CFP®, CIM® is a Financial Planner and Associate Portfolio Manager with Louisbourg Investments. You can find more from him on Facebook and LinkedIn. Comments or questions may be submitted to Marcel at firstname.lastname@example.org, or he may be reached at (506) 383-5204
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This writing is for general information purposes only and is not intended to provide legal, accounting, tax or personalized financial advice. If you are not sure how to proceed with a request for further information, seek help from a professional. Any opinions expressed are my own and may not necessarily reflect those of Louisbourg Investments.