Sensible risk management is the balancing of benefits and risks, and more importantly figuring out how to manage significant perils that can cause real harm and suffering to you and your family.

What are some examples?

If I am 35 with four young children and a spouse who does not work outside the home, one of my biggest risks is unexpectedly dying too young, causing my family to lose the income I would have otherwise earned until my retirement. The risk of me dying at 35 is very small, but the financial and emotional consequences to my family of me dying young are massive. Fortunately, the cost of protecting my family from this improbable but very impactful risk is also very small when weighed against the financial consequences, so a prudent person would always have sufficient term life insurance to protect their loved ones. This is a simple and elegant example of risk management, as opposed to the illusion of risk avoidance, which is unattainable.

You could also tell a similar version of this story for fire insurance on a house. Low probability event + Terrible outcome if the event happens + Inexpensive safeguard = Get some fire insurance.

What about investing?

There are two major risks that are most disconcerting to investors:

1. Running out of money in retirement, or retiring with too little money
2. Permanent loss of capital

What are the solutions to these risks?

1. Systematically save a preset portion of your income, and do not over consume, which risks your family's financial well-being in the future. It is critical to remember that when you go into debt for consumption, you are spending your future income, and even at a borrowing rate of zero you still have to pay the money back from that future income. The vast majority of our clients abide by this practice, which is why they have accumulated significant capital.
    
2. Stick to a spending rate in retirement that is sustainable and accounts for the reality that markets do not return 6% per year every single year even if they average 6% (or whatever number you choose to assume ) over the long-term. Markets can and do go down as well as experience flat periods, therefore portfolios and investment strategies will go in and out of favour in the short-term. We need to be cognizant that this risk of irregular returns in the short-term does exist.
    
3. Do not over invest in “safety”. GICs, cash, etc. have paid very little in yield the last few years, so after-tax and inflation you are losing money (i.e. purchasing power) every single year. Many investors over allocate to "safety" for their long-term money and this is costly to your future self. Over-allocating to "safety" is only a good bet if you believe in Armageddon, and if that is your bet then that is a whole other discussion that is beyond the scope of this blog post.
    
4. Invest for growth knowing that the least risky thing you can do for the long-term is to bet on economic innovation and entrepreneurial spirit that, historically, has grown capital over the long-term at a rate greater than inflation. Also know that markets go up and down in the short-term, so we minimize this short-term return risk by holding cash (or equivalents) for two years’ worth of fixed spending needs. Put another way, if the short-term risk of stocks is fluctuations we mitigate this by keeping our short-term needs in cash, which is completely stable.
    
5. Concentration risk: Minimize the amount of your portfolio that is invested in highly cyclical or speculative areas, especially when things are going really well and you do not want to sell and your risk appetite silently increases. This is sensible risk management as your concentrated holdings have a high potential payoff, but also a high risk of cyclical sell offs that are financially and emotionally painful. It is wise to remember that a person's risk profile or "animal spirits" do change through the investment cycle and is not, as some believe, stable. In fact, risk profiles unfortunately often work against investors as they are driven by fear or the absence of it. Risk appetite should be at its highest when fear is highest, yet we often feel the opposite.

There is no perfect wealth plan, only reasonableness based on your financial goals and risk tolerance. In fact, we all suffer from regret in investing, which is why it has been said that a key part of sensible investing is regret minimization and that the best antidote for this is goal focused investing, meaning focusing on you and the financial goals you know are important and that you need to accomplish. That is how you can truly achieve "financial success" and avoid catastrophic failure that often has its root in fear and/ or greed, which unfortunately we all suffer from.

They are clichés only because they are true: "investing is simple, but not easy" and “hindsight is 20/20”. We all can look back and see what we should have done in the past with finances and life, yet the future is and will always be unclear. What is always clear, however, is the fact that in retirement you need income for the remainder of your life, that we should never risk what we have to get what we do not need, and that achieving sound and sensible financial goals will allow you to live your life well. That is what sensible risk management is all about.

All the best,

Randy, Ian, and the team at R&R Investment Partners