Managing Risk

Avoid it as much as possible. Many do this by simply getting out of equities and investing in money market funds, CDs and Treasuries. In other words, low-risk cash equivalents that offer security of principal. However, the cost of principal security as we have discussed is the risk that portfolio returns will be relatively low, and that achieving financial goals may take much longer than would be the case using other strategies. If a low-risk investor has a fixed time frame within which he or she must work, lower returns may require higher levels of capital to achieve desired goals.

Retainit. Investors who neither avoid risk nor look to transfer risk end up retaining risk and must manage their investment portfolios carefully. Management of market risk, Sequence of Returns Risk, Interest Rate Risk, is still entirely the job of the investor. By retaining risk, investors may end up using investments such as equities, longer duration fixed income vehicles, or even alternative investments that may provide higher returns and shorten the investment time horizon. But the risks we have discussed mean that there will be risk to capital and no guarantees. Some investors may just hope that they retire at the right time and that the market will cooperate with their retirement income needs. However, hope is not a plan.

Transfer it as much as possible. It is possible to reduce the risk retained by the investor by transferring a measure of the risk to those more capable of handling it. It is up to the investor and financial professional to determine which risks are of greatest concern, how to quantify those risks, and to determine what portion of that risk they wish to transfer. Transferring risk is not free; it is likely that there will be associated costs and/or fees. However, by transferring risk, an investor may achieve higher returns than are possible by avoiding risk, and with less volatility than if the risk was retained.