Mon, 10 September 2018
Does this sound familiar?
You go in to invest and you tell the adviser you don’t want to lose too much and you are not greedy but you want some growth.
You fill out a risk tolerance questionnaire. This is basically a form that asks you how much you are comfortable losing.
Since you don’t want to lose much you score kinda moderate.You are then allocated into a moderate allocation based on your score and conversations.
A year later the market is up 15% and you are only up 6% and you are wondering what went wrong and you are unhappy.
You are a Victim of a “Risk Tolerance Questionnaire.”
The problem is a risk tolerance is purely emotional. Is it a good idea to invest based on emotional decisions? Of course not. Yet the industry promotes this model as a tool for investment decision making.
I think it is safe to say we all don’t want to lose money right? From recent surveys, most high income investors tend to value safety over growth.
So how do we handle our fears of losing money with a more objective approach so we can get the long term outcomes we want?
A better solution: Time Based Allocation focuses on your cash flow needs and getting the performance you desire.
How long does it take a market to recover from a crash?
10% Drop - 1.61 years
20% Drop - 2.8 years
30% Drop - 3.6 years
40% Drop - 4.25 years
Knowing this can allow for better allocation and the potential for better growth. You look at your cash flow needs in blocks of time and match to an allocation.
How much cash do you need:
Cash flow needs in the next 1 to 2 years - allocate to capital preservation
Cash flow needs years 2 through 4 - allocate to dividend and income strategies
Cash flow needs years 4+ - allocate to opportunity and growth
So instead of just automatically moving to lower yield, more conservative strategies based purely on emotion, you plan out your cash flow needs and allocate more based on market fundamentals and real investment strategy.
With your cash flow needs covered and a safe foundation set up (including income streams, emergency funds, tax protection, etc.) you have a better framework to deal with the ups and downs of the market. Volatility can become an opportunity rather than something that stresses you out.
And you have a better chance to get the long term performance you are really looking for.
If you would like to know how we incorporate this in an overall financial plan you can access the entire suite of Wealth For Life Planning Tools and to no cost for a limited time. ($995 value.)